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One Size Fits Some: Single Asset Real Estate Bankruptcy Cases

Kenneth N. Klee

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ONE SIZE FITS SOME: SINGLE 1~SSE'T REALESTATE I3ANKRUPT~Y ~ASES~

Kenneth N. Kleej-~-

For several years tc debate has raged over whether .single asset real estate

ctcses should be singled ou"t for special treatment under the Bankru~itcy Code.

Under the current .~4 million debt ca1~, these cases involve apartment housesand sm~cll office buildings. But Goth Houses of Congress have ~iasser~ legzsla-tion that will re~ieal dhn, $4 million ca~i, potentially subjecting large officebuildings, sho~~iin~ centers, and ~ierhaps hotels to ex~iedited discriminatorytreatment in Chapter Y 1 reorganization cases. In this Article, Professor Kleeattempts to inform the debate by presenting empirical data gathered from anational questionnaire and cross-checking the data against the case files of abunlzru~tcy judge in the most active judicial district in tlae country. Tlaeresults are striking. Asset values rather than amounts ozuin~• stand out asreliable predictors of Milan confirmation. Sur~irisingly, 'value-to-loan ratiosare less reliable than asset values standing alone. The data shorn t12at va.lu-~~ble properties have u much greater ~irobaGility of confirming a f lan thanless valuable ~ro~ierties. The Article suggests that if Congress desires to dis-criminate against single asset real estate debtors, it should draw the line ata~i~iroximately .~7—~8.2 million in asset value rather than changing currentlaze to discriminate against all single asset real estate debtors.

INTROAUCTTON .................................................1286

~. WHY REUI2GANTZ~ S~ CASES AT ALI.? ........ . ......... 12$9

A. The History of Real Property ReorganizationCases...............................................1289

B. How Chapter 1 J. Functions for SAIZ~ Debtors .......1293C. Arguments For and Against Reorganization ......... 1296D. The Politics .........................................1302

IT. Z'I-IF. 2001 AMENDI~I~N'I' EXPLODES THE GE1T' ...............1303

A. The Rationale £or Congressional Action ...... , , ....1303

-~ O 2002, Kenneth N. Klee. All Rights Reserved.-~•f Professor of I.aw, University of Calitornza at Los Angeles (UCLA} School of Law.

The author gratefully appz~eciates and ack~~owledges comments of Professors Daniel J. Bus-sel, Caroline Gentile, Robert Goldstein, Lynn M. L.oPucki, 12ichard Sander, T~irk Stark, andElizabeth Warren, on previous drafts o£ this Article. The author gratefully appreciates andacknowledges valuable technical assistance by Joseph Doherty, Associate Director for Re-search, Empirical Research Group, UCLA School of T.,aw, azzd research assistance by JacobSimon, UCLA. School of I,aw, Class of 1998, Steven Cademartori, UCT..A School of Law,Class of 2000, and Arusi Loprinzi, UCLA School of Law, Class of 2003. The author is alsograceful for generous funding from the National Conference of Bankruptcy Judges ~ndow-mentfor Education and the Faculty Grants Program awarded by the Council on Researchof the Academic Senate at UCLA.

].285

1288 CORIVLI,L LAW .I-~EVIEU~ [Vol. 87:1285

aftei the order° for relief, unless "the debtor has filed a plan of reor-ganization that has a reasonable possibility of being con~rrried withina reasonable time,"10 or the debtor in possessionll has comrrzencedmonthly paynnents equivalent to interest'` to each secured cx-editor.13

If the X001 Axxzendment becomes law, however, mortgage holderscan prernat:urely flush out of the bankruptcy system some large realestate developers or owners that have liquidity problems before thelatter have a reasonable chance to reorganize.'` By threatening to doso, mortgage holders can control the Chapter 1 X process to their ben-efit. They can deczde 'whether to seize the property for potential up-side gain or leave it in Chapter 11 to serve their other purposes.l'Their benefit will come at the expense of property owners, generalunsecured creditors, and the public that subsidizes the cost of operat-ing the banlrruptcy system to achieve a public good.

.After testifying before Congress about the forerunner of the 2001Amendment, I recognized the desirability of gathering empirical datato determine whether large SA.RE debtors differed From small SAKEdebtors in their Chapter 11 experiences. X exazz~ix~ed the case law andgathered information in unreported cases to determine whetherSA12E debtors conf rmed Chapter 1 X plans. By analyzing plan confir-mation rates over the past t~cventy years, this Article tests the wisdorri of

ing text (discussing the uncertainty of an extension motion due to judicial hostility towardSAS debtors).

1~ 11 U.S.C. § 362(d} (3) (A).

I 1 Although the statute refers to a "debtor," it actually means a "debtor in possession"acting as the legal representative oP the bankruptcy estate. See icl. ~§ 323(a), 1107(a).lz Soane courts and comrnez~tators mistakenly characterize the statute as requiring the

payment of interest. Kather, the payments are "in an aznotu7t equal to interest." Sec i.d.§ 3G2(d) (3) (B). Unless the creditor is oversecured or ehe debtor is solvent, the statutefoz-bids the pay►nent of postpetition interest. See id. ~~ 502(b) (2), 506(b), 726(a) (5). Infact, if the crediCOr is oversecured, alChough postpetition interest witl accrue under~ 506(b), the statute might forbid the payment of postpetitioi~ interest prior to the conclu-sion of tl~e case as well. See Orix Credit Alliance, Iz~c. v. Delta Res., Inc. (X~z ~e Delta Res.,Inc.), 54 F.3d 722, 730 (11th Cir. 1995).

1 =; See '11 U.S.C. § 362(d) (3) (B).

i`~ See Ira ~e Klcernko, Inc., 181 B.R. 4'7, 4J (Bankr. S.D. Ohio 1J95) (noting that thepurpose of § 3G2(d) (3) is to "impose an expedited time frame for filing a [confirmable]plan" in SAKE cases); David B. Young, Automatic Stay Isseces: Selectecl Decent Develvjrmrn~s, in 2232'Cl l~NNUi11.. ~iURR13N't DL.VLLOPNII?NTS IN ~ANKRUPTC:Y AND REOIiGA~IIZ.~ITION ~, ~1 ~~I.Z

Commercial Law &Practice Course, Handbook Series No. A-820, 2001) ("11 U.S.C.362 (d) (3) ...seeks to place tl~e debtor ors a fast crack and to permit the rxioi•t~age lender

to foreclose unless the debtor acts swifCly.").

1 -"> `That is why mortgage holders financed the lobbying effort to press for this amezid-rnent. See generally 73~enlz~~te~itcy, at http://www.opensecrets.org/news/bankruptcy/in-dex.hmi (last visited Mar. 15, 2002) (indicating that during the 1999-2000 lobbying cycle,finance and credit card companies contributed ~9 million, and that during the same cycle,cornmerciai banks contributed X29 million, and credit unions coiatriUucc;d x$2.1 million—almost two and a half trines the amount spent by this industry dux'ing the 1996 presidentialcampaign}.

2002] ONE S17~ FITS SOMA J.28g

treating large and small SAIZ~ debtors alike in a manner diffea eastfrom all other Chapter 11 debtors,

Part I of this Article examines the history and policy behind SAREreorganization and asks a threshold question: Why should SAKE debtors have the opportunity to reorganize at all? Compelling policy rea-sons favor reorganization of SARE debtors, even though theories ofallocative efficiency might indicate otherwise. Part XI reviews the 2001Amendment's uniform procedure for all SAKE reorganizations bycharging the definition of SAKE to eliminate the $4 million cap andanalyzes the policies that the amendment implicates. Part III dis-cusses original data analyzing real estate cases to see how they fared ixzbankruptcy and finds that larger S.f1.RE debtors above the $4 millioncap have higher Chapter X 7 confirmation rates. In Part IV, this Articleargues that these findings do not justify Congress's proposal to repealfile SAKE ~4 million cap because Chapter 11 £unctions well for largerSAKE debtors. Congress acted on the basis o£ a hunch instead o£ do-ing its homework.

IWHY ~ORGANIZ~ SARE CASES AT L~.I.,L?

The question 'whether or under what conditions single asset realestate cases should be able to reorganize under the Bankruptcy Coderequires an evaluation of the costs and benefits of reorganization ascompared to foreclosure under state law. To place the evaluation ii1context, this Part begins with a brief history of real property reorgani-zations and describes how Chapter 11 reorganization cases work. Itexamines the arguments for and against allowing SA.R~ cases access toChapter 11 at all and focuses on the political motivations that led tothe adoption o£ the 200]. Anaendnnen.t rather than exclusion of SAKEdebtors from Chapter I1.

A. The Histo~c~y of Real Property Reorganization Gases

During the 1930s, the deteriorating economic climate in theUnited States led to massive defaults in the repayment of real propertymortgages.16 Eco~~~mic disaster threatened not only the debtors whoowed mortgage obligations, but also the financial institutions, particu-larly savings banks, that held the mortgages." As debtors defaulted,

lc See T-Iomer I~'. Caz•ey, Re«l Fro~ier~ty: Post De(~•ression a~n.cl Futzere,,J. Lrcwi. & PoL. Svc:.,Apr. 1943, ae 101, ].O1 ("Foreclosures reached staggering proportions [fl•om 1931 to 1~J35]and bankruptcies were occurring at an ever accelerating rate,").17 ,SCC ~LYfUS WICI{L.R, THIi ~AN[CING ~r1NICS OFD THF. Gx~nr• DeYxcsstoN 1G (1996) ("Real

estate lending, px-ixilarily nonfarnz, , ..was an important source of ttx~settled banking mar-kets during the Great De~~ression."); Milton EsbitC, Bcenit Portfolaos and Bccnk Tc~ilza~res During

tlae Great Detnession: CTticccgo, 46 J. Eco~v. HisT. 455, 45'7 (1986) ("[~']ully 95% of the bank

ecoubles in Chicago were predicated on real estate." (internal quotation marks omitted));

1290 CORNELL LAW REVIEW [Vol. 87:1285

~o~ tgage holders connmenced Foreclosure proceedings and financialinstitutions began to hold recoi d title to enormous amotYnts of realproperty.' Mazy of these financial institutions faced the Hobson'schoice of holding real estate that generated little income but carriedtax, maintenance, and insurance liabilities, or selliizg the real estateinto a thin nnarket with :few b~,tyers and distressed prices.l`' Yet inmany states, financial institutions could i~ot intervene to protect theirinterests by Foreclosing on mortgaged properties, because the stateshad imposed moratorium laws to suspend foreclosures.z~' As a result,the United States faced the prospect of numerous financial institutioninsolvencies.21 In addition, Congress saw a risk of undermining theU.S. economic system by allowing real property defaults to cause per-vasive dispossession of private ownership. Partially to ameliorate thissituation, Congress enacted Chapter XII of the Bankruptcy Act to per-mit individual and partnership debtors who owned real property theopportunity to reorganize.22 By ernacting Chapter XII, Congress cre-

Thomas S. Stone, Mortgage Moruto~zt~, 1 X Wis. L, ItLV. 203, 206 (1935) ("The wave of foreclo-sures ...was of little benefit to creditors."); Current Legislation, Emergency Mortgage I egisl~-tio~z, 8 Sr. JoHVS L,. REV. 204, 206 (1933) ("Savings banks and insurance companies withtheir millions in mortgages ...were caught in the deluge of foreclosure and in this time of~chaos, President Roosevelt declared the Banking Holiday.").

1H See Carey, su~rra note 16, at 104 (" [P] roperty passed in great volume to the creditorclass during the intezval from J930 to 1937."). Contemporary litex-ature contains the fol-lowing hyperbole: "When one realizes that approximately 5U per cent of Che farm lands inCentral and Northern California are conCrolled by one institution—the Bank of America—tlie irony o£ these ̀ embittered' Farmers defending their ̀ homes' against strikers becomesapparent." CAREY MCWTLLIAMS~ FACTORIES IN "I'H~ FIELD: THE STORY OF MIGRATORY FARNfLABOC2 IN CALIFORNIA 233 ~I939~.

1~ See, e.g., Stone, su~ira note 17, at 206 {"[T]he past few years lave found banks andother lending i~ZStitutions loaded down with physical properties which they cannot oper-ate."); Arthur E. Sutherland, ,Jr., Foreclosure and Sale: Sonae Suggested Clcanges in tlae Nezu YorkP>•ocedure, 22 CoKNi:LL L.Q. 216, 217 (193) ("The gxeat lending institutions are reluctantto load themselves with foreclosed real estate ....").

Z~~ See, e.~:, Robert H. Skiiton, Mm~gage Moratoria Since 1933, 92 U. Pa. T.. 12rv. 53, 88(1943) ("The chief criticism that may be made of the New York moratorium is that it wastoo inclusive. Commercial properties , ..were protected against the consequences of de-fault in principal.") ; see ~ilso William L. Prosser, The Minnesota Mm•tgr~ge Moratorium, 7 S. CAL.I~. 12~v. 353, 355, 360–G3 (1934) (discussing Minnesota's executive and legislative responsesto the wave o£ foreclosures and forced sales); Stone, su~rrca note 17, at 219-20 (discussingthe Wisconsin Mortgage Moratorium Law of 1933); Current Legislatio~~, su~ircc note 17, at206-09 (discussing New York's nnortgage moratorium statutes).z1 See Raymond J. Mischler, After tlae Mortgage Moratorium—W{aat?, 19 Iowa L. RLV. 560,

561 (1934) ("Foreclosures and forced sales were reaching proportions that threatenedstate and national stability.").

z~ See Morris W. Macey & M. ~1~zlliam Macey, Jr,, 1'fae C/aa1~ter XII Cla•rysalis, 52 A,u.Bwrrxx. LJ. 121, 123 (1978) ("Chapter XII was ...developed principally to meet an emer-gency situation prevalent in Illinois and, to some exteizt, Massachusetts."). Congxess en-acted Chapter XII as part of the Chandler Act of 1938, Pub. L. No. 75-696, ch. XII, 52 Stat.840, 9X6-30 (repealed Uy Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, § 401, 92Star. 2549, 2682), and at the same Cline it passed Cl~apeer X of the Bankruptcy Act tofacilitate corporate reorganization o£ different kinds cif businesses, including those owningreal property. See id. ch. X, 52 Stat. at 8$3-905 (repealed by Bankrupi:cy .lZeform Act of

2002] ONE SIZE FITS 5011 1291

ated a beneficial legal mechanism to prevent financial institutionsfrom either conducting massive resales of foreclosed real estate intodepressed markets or retaining concentrated ownership o£ real prop-erty on their balance sheets. Before the enactment of Chapter XII,SAKE debtors either renegotiated consensually with their mortgageholders or liquidated the property under the Bankruptcy Act of 1898or state mortgage foreclosure laws.

When Congress enacted the Bankruptcy Code in 1978, it contin-ued to permit SAKE debtors to reorganize under the same laws andrules as other kinds of Chapter 11 debtors. A property owner was eli-gible to £ile for relief under Chapter 1 ]. whether the owner was anindividual, partnership, ox corpoxation.23 The 1978 Bankruptcy Codegave all kinds of SAKE debtors a breathing spell to permit them torestructure their property and their mortgage.

In 1994, however, the law changed fundamentally f'or some SAKEproperty owners when Congress adopted special rules fox SAKE debt-ors with secured debts o£less than ~4 million ("small" SAKE debtors}.In those cases, Congress restricted small SAKE debtors to an expe-dited Chapter 11 procedure designed to confirm a plan quickly orforce the debtor to pay the mortgage holder. Debtors who could doneither faced losing their property to Foreclosure. To protect ~cnortgage lenders in SAKE cases having secured debts n~.ot greater than ~4million,24 the 1994 amendments added an additional procedure bywhich a real property mortgage holder could obtain relief fronn ~ 362of the Bankruptcy Code's automatic stay against lien £oreclosure.25

1978, § 401, 92 Stat, at 2682); see ce~so Charlestown Say. Bank v. Martin (,i~n re Colonial RealtyInv.), 516 F2d 154, 158 (1st Cir. 1975). The court stated:

The power to prevent secured parties from availing o£ their contractualremedies ... ,and to compel those creditors ... in possession at the tinneof filing co return tl~e debtoz's property is essential to preserve the possibil-iCy of a successful rearrangement of the debtor's affairs. LitCle hope of re-suscitation would remain for the debtor disembowelled just prior to filing.

Id.z~ Individuals (]zuman beings), partnerships, and corporations are eligible to be

Chapter 11 debtors. See 11 U.S.C. §§ 101(41), 109(b), (d) (2000); ToibU v. Radloff, 501U.S. 157, 166 (1991} (holding tl~ac an individual debtor not engaged in business was eligi-ble to file under Chapter 11). See generally infra note 30 (discussing the meaning of theterms "individual" and "corporation" in the Bankruptcy Code). Individual debtors withregular income and noncontingent, liquidated secured debts less than $871,550 and non-contingent, liquidated unsecured debts less than $290,525 may Zile Chapter 13 cases in-stead o£ Chapter 11 cases. See 11 U.S.C. ~ 109(e) (2000) (as amended effective April 1,2001). Geizerally, Chapter 13 cases are less expensive and more effective than Chaptex J1cases. Thus, an individual SARA debtor who is eligible might choose Co fle a ChapCer 13case instead of a ChapCer 11 case. This Article assumes that the debtor files for relief underChapter 11.Z4 For the Code's definition of °single asset real estate," see ,su1yra• note 6.2~ See Bankruptcy Reform Act oi' 1994, Pub. L. No. 103-394, § 2]8(b), 108 Stal. ~k106,

4128 (codified as amended at 11 U.S.L. ~ 362(4)(3) (2000)); see infra note 2G. Lenderswith secured loans of al least ~4 million did not receive tl~e be~zefits of these protections,

1292 CORNELL LAW REVIEW [Vol. 87:1285

Section 362 (d) (3) permits a S.ARE mortgage holder to get relief fromthe automatic stay to foreclose unless, within ninety days after the or-

der for relief; the debtor files a confirmable plan ox begins makingmonthly payments to the mortgage holder.26 Thus the amendmentsminimize the mortgage holder's out-of-pocket loss by shortening theChapter 11 process or forcing the debtor to "pay to play" by makingcash payments to the lez~.der. This shifts the risk of delay from ehesecured lender to the debtor. It also creates a barrier to entry thatdiscourages small real estate owners from filing for Chapter 11 re-lief.~' Mortgage holders and their lobbyists justified the provisionbased on an alleged "shared experience" that, in most real estatecases, debtors file solely to delay foreclosure.2~ They convinced Con-

although they could seek relief from the automatic stay under § 362(d) (i) or (2). See 11U.S.C. § 362(d) (1)—(2). Presurn.ably Congress adopted the ~$4 million cap in 1994 becauseis thought that different policy concerns governed larger cases.

2~ Section 362(d) (3) provides as follows:

[The court shall grant relief from the automatic stay of § 362(a)] (3) withrespect to a stay of an act against single asset real estate under subsection(a), Uy a creditor whose claim is secured by an interest in such real estate,unless, not later than the date that is 90 days after the entry of the ordex forrelief (or such later date as the court may determine for cause by orderentered within that 90-day period)---

(A} the debtor has fled a plan of reorganization that leas a reasonablepossibility of being confirmed within a reasonably time; or

(B) the debtor has commenced monehly payments to each creditor•whose claim is secured by such real estate (other than a claim se-cured by a judgment lien or by an unmatured statutory lien), whichpayments are in an amount equal to interest at a current fair marketrate on the value of the crediCor's interest in the Y•eal estate.

11 U.S.L. § 362(d)(3).

L7 One commentator believed that the 1994 amendments would cause the bankruptcycourts to experience ixlcreased efficiency because the amendments would "minimize filingswhere nn real proUability of confirmation exists." See Co•~nmercircl rend Creclit Isszaes in Ba~xk-r~u1~lcy: Hea~~ing• Before t{te Subcor~t~~t. on Courts f~' Adnain. Practice of the Senule Gorra7~r.. o~z tlaeJecdiriri~y, 102d Long. 89 {1991) [llereinafcer Co~nntc~rcial tend Credit Hearing] (statement ofMary Jane Flaherty). Althougi~ it is obvious Chat a debtor would prefer aninety-day delayto immediate foreclosure, as a nnatter of cost/benefit analysis, the foregoing speculauo~~sappear to Ue sound. Debtors that own small real estate projects will be less inclined to paya bankruptcy attorney's retainer, a Chapter 11 filing fee, the quarterly U.S, crtrscee's fees,and the other substantial incremental cows of filing for Chapter• 11 when the limitations of§ 362(d) (3) operate to compress and restrict their opportunity to reorganize. See 23 U.S.C.§ 1930(x) (3), (6) (Supp. V 1999). At the margin, they will walk away and allow lenders toforeclose or give lenders a deed to the property in lieu of foreclosure. Another commenta-tor has speculated that the 1994 amendment would discourage small real estate debtorsfrom filing for Chapter 11 relief, thereby resulting in earlier foreclosures under sCaCe law.Sne,John C. Murray, Tlae Lencle>•'s Guide to Single tlsset Deal Estate 14an.1trz~1~tcies, 31 I2~nL T'ao►~.~'itoa. & TR. J. 393, 448 (1996).

LH See, e.g., Co•~nntercial a~xcl Credit Heardng, su~ira note 27, at 88-89 (statement of MalyJane Flaherty) ("The problem with single asset cases is that there is usually no reasonableprospect cif reorg'anizaCion. The bankruptcy filing is simply used as a legal method to delayforeclosure. I.e~~ders typically receive relief from the stay, but only after subseantial delayand expense.").

2002] ONE S.I/~Fs' FIIS SOME X293

gress that these cases seldom result in confirmed plans but instead usethe resources of the federal courts for improper dilatory purposes.z`•'

In 2001, once again bowing to pressure from mortgage holdersand their lobbyists, each House of Congress introduced and passedbills repeaxing the $4 million cap and subjecting all SARE debtors tothe expedited procedures that since 1994 had applied only to smallSAIZ~ debtors.

B. How Chaptea l.1 Functions for SAlZE Debtors

Befog°e analyzing the 2001 Amendment, it is usefiil to understandho~v Chapter 11 functions for SAIZE debtors and to consider whetherSARE cases should reorganize at all. Coni;inuing the pattern of fed-eral reorganization relief that started during the Great Depression,the Bankruptcy Code allows almost any kind of SA12E debtor to initi-ate aChapter 11 reorganization case, whether the debtor is ~n individ-ual, partnership, or corporation.~30 After filing a Chapter I1 petition,the debtor ordinarily remains as a debtor in possession9~' with the

L`~ See id,; Bankrtc1~tcy Xeforrn: Hearing Before the Sacbcomm. an F,con. f~ C:orrtmerci~cl Laru of

tlaeHouse Comm. on t,1ce,Jucliciccry, 103d Cong. 532 (]994) (statement of Warren T.asko, ~xec-

utive Vice President, IVlox~tgage Bankers Association of America} ("~'he survey also confirms

that Cliaptez• 11 is tieing used by developers and owners of single asset real prape~•ty for

delay, not f'or legitimate reorganization of a business."). The subcommittee manager of

ehe bill in tl~e House of Repx•eseritatives described the 1994 amendments as "desigr~ecl to

curtail bankruptcy fraud and abuse ax-~d reduce the unnecessax-y costs and delays of~ the

bankruptcy process." 140 Co~rc. Rre. H10,'771 (daily ed. Oct. 4, 194) (stateinciit of Rep.

Synar) .

''~> T'he Bankruptcy Code rises the Germ "individual" co mean a parCicular human be-

i~ag. .See Farm Fresh Poultry, Inc. v. Houton Co. (In rc~ Houton Co,), 43 B.K. 389, 391

(Bankr. N.D. Ala. 1984) ("The tez~An ̀ andi~~idual' is not i~~cluded in the definitions found in

11 U.S.C. § 101; however, it may be said to mean generally a single human being as distin-

guished from a social group or insCiCUtion.");David Swarthout, Noce, When Is ccn Indir~iclual

ci Co~~i~ratioya?—Wla~n, tlr.e Court 1l~Xisinter~rrets a Statute, 17zrct's Wlaeia!, 8 Ami. Ba,vita. T~sr. I..

Rev. 151, 152 ri.9 (2000) (citing '1"oiL~ v. Radloff, 501 U.S. 157, 160-61 (1991), for the

proposition that the Court's use of the term "individual" excludes "corporate clebCors and

only refers] to human beings."). The Bankruptcy Code's definition of "corpoz~acion"

pt•obably includes limited liability companies, limited liability partnerships, and business

tz•usts, but not true tz~usts. See ll U.S.C. § 101(9) (2000) (defining "corporation"); Sally S.

Neely, Part~aers/ai~s cencl Yrertners a~acl C,imitecl I iability Cona~anies cancl Members in X3cin~tr•ae~~tcy.•

Pr%o,rccls fir Refor~~rt, '71 Apt. Btwxx. L..]. 2~1, 286 (1997) (stating that a I.I.0 "appeals co be a

corporaeion" under tl~e Bai~krixptcy Code's definition of "corpoi•aeiozi");Thomas F. Blake-

rnore, I,irreilecl I ir~bi.lr.Gy Corn~~anies ca•~zcl dhn, BanJi~~u~~tey Code.• A 1 eclanieccl 1Zcroieru, Ayi. B~Nitit.

Insi•. J. (Am. Bankr. Tnst., Wash., D.C.), Jtizze 1994, at 12 (staeiz~g that "a I..I.0 would appear

to qualif}~ as a ̀ coz~poration' under [Bankrupecy] Code § 101(9)").

31 See 11 U.S.G. § 1101 {1) (2000) (defining "debtor in possession" t.o mean the debtor

except when a trusCee is serving in the case). It is rare f'or Chapter 11 t~~ustees to be ap-

pointed oz~ elected. See icl. § 110~(a) (2000) (speci£yin~ grounds foi• the appoiz~cmenc of~ a

Chaptea~ X1 trustee).

1294 COR.NELL LAW I~VIEW [Vol. 87:1285

power to operate its business,~2 sell assets,33 obtain credit,~~ and pro-pose aplan of reorganizatioi~..~~'

For at least the last sixty years, no.osC SARA debtors in bankruptcyhave had over-leveraged capital structures where a decline in rents (orinability to rent) produces a cash flow insufi'~cient to service their se-cured debts. Some debtors have obtained junior mortgages to createadditional short-term cash flow, but this strategy often adds more debtwithout solving the debtor's long-term liquidity crisis. Ultimately, theliquidity crisis escalates to the point where the mortgage holderthreatens to t'oreclose and the debtor walks away fa om the property,renegotiates with the rcnortgage holder out of court, ox files a ChapterX 1. petition. Tn these Chapter 1 T cases, the debtor's plan of reorgani-zation almost always proposes debt relief Debt relief tales manyforms, ranging from a simple extension of the xn~aturity date or anadjustment of the interest rate or of the debt amortization period, toforgiveness of indebtedness or the conversion of debt to either equityor a participating mortgage. Indeed, a principal purpose of bank-ruptcy is to give the debtor an opportunity to solve its liquidityproUlems.~~'

In some SAKE cases, the borrower needs to restructure both thesecured debt and the business operations. For example, a buildingmight requiie construction for completion, expansion, retrofitting,repair, or renovation. In this kind of SAKE case, the debtor in posses-sion first must obtain additional capital to finance the needed con-struction in order to prove that its reorganization plan is feasible. Ifthe value of the properey is less than the mortgage debt, the debtor inpossession probably will i~ot obtain additional financing on an un-secured basis or even with a junior lien for secuxity. Sometimes thedebtor in possession obtains debtor in possession financing securedby a senior lien on the properry.~'' Most lenders, howevei, will notprovide financing to a postpetition debtor in possession uzzless thedebtor in possession secures the new credit with a so-called "prixn~ing"

3L See id. §~ 1107(a), 1103.3 See id. § 363.

3`~ See id. § 364. '

ire See icl. § 1121(a) (giving the debtor the right to file a plan).~;~ See, e.g., H.R. Rr,r. No. 95-595, at 221 (1J77), i~ejrrintecl in 1978 U.S,C.C~,A.N. 59f3,

6X80 ("The purpose of [a] reorganization .. ,case is to formulate az~d have confirmed aplan of reorganization ... f'or the debtor."); Elizabeth Warren, 13anl~rtt/~Gcy Policyina/ring- inan Im1~eifect Warld, 92 MicFi. I,. Rrv. 336, 372 (1993) (characterizing Chapter 11 as "ct•eatingan opportunity for a business to survive its im~xiediate financial crisis"). I3tit see Kevin A.Kordana &uric A. Posner, A Positive'1'heory of Claa1iter 11, 74 N.Y,U. L. Rr~v. 161, 164 (1999)("tiVe assume el~at the puz•pase of Chapter ll is to mirz3zxiize the cost of credit.").

37 See 11 U.S.C. § 3f4 (giving the debtor in possession the ability to obeain postpeci-tioA~ financing).

2002] ONE SIZE FITS SOME 1295

lien. with priority ahead of the prepetitioai rnortgages.3s The law per-mits this to be done only if the court determines that there is ade-

quate protection of the prepetitio~~. mortgage holder's interest in the

real properry.39 Although a value cushion is a common form of ade-

quate protection,`~0 where the amount of prepetition mortgage debtexceeds the value of the property, this method of protection is un-available. Tn some S1~RE cases, however, the value added by new con-seruction will provide a sufficient cushion to cover new postpetitionfinancing and aclequaeely protect the prepetition z~ortgage holder'sinterest in properry.41 Even if the debtor in possession cannot obtaindebtor-in-possession financing, it may be possible for existing ox ne~vequity owners to infuse equity capital under a reorganization play.Unless the prepetition mortgage holder votes to accept the plan, how-ever, the equity owners may infuse equity only if the debtor uses amarket process to determine the value of the new equity.42

While the debtor in possession attempts to obtain debtor-in-pos-session £znancing or new equity, the law automatically stays the se-

cured lender from pursuing its foreclosure rights.43 Although it ispossible fox the debtor to nnake periodic cash payr~.ents to the lender

as a form of adequate protection,44 not all courts require current pay-

inent of postpetition i~ terest on prepetition tnortgages.4' Under thereorganization plan, unless the debtor is solvent, the undersecuredlender's clam will include principal and prepetition interest, b~xt n.otpostpetition interest.~6 Fox example, assume that a debtor owes amortgage holder. ~1 million under a note bearing annual interest at1Q% and secured by peal property worth $800,000. I£ the court con-firms the reorganization plan and it is effective one year after the

~8 See •r'd,. § 364(4).=;~ See id. ~ 361; id. § 364(cl) (1) (B).~~> See, e.g., Piscole v. Mellor (In 7•e Mellor), 734 ~'.2d 1396, 1400 (9th Cir. 1984); Mc-

Combs Props. VI, Ltd. v. First Tex. Say. Assn (In re McCombs Props. VI, Ltd.), 88 B.R. 261,266 (Bankr. C.D. Cal, 1988).

`11 See, e.g•., In reLedgemere Land Corp., 125 B.R. 58, 63 (Bankr. D. Mass. 1991).4~ See Bank of Am. Nat'1 Truse & Say. Assn v. 203 N. LaSalle St. P'ship, 526 U.S. 434,

445-58 (1999) (holding that if the new value principle exisCs under the Bankruptcy Code,it requires the equity co be exposed to a za~arket value such as through an auction oz~ thetermi~iation of the debtors plan exclusivity).43 See 11 U.S.C. § 362(a) (2000).44 See icl,. § 361(1) .'~~ See, e.g•., Orix Credit Alliance v. Delta Res., Inc. (In re Delta Res., Inc.), 54 I'.3d 722,

729 (lJth Cir. 1995) (noting that if the mortgage holder is oversecuzed, some courts per-mit postpetition interest Co accrue, but do not permit its payment until the conclusion ofthe case}, If the morCgage holder is undersecured, it might not have the right Co paymento£ postpetrtion interest as long as the value of the real property is not declining. See, e.g.,United Say. llss'n v. Tiznbcrs of Inwood Forest Assocs., Ltd., 484 U.S. 365, 382 (1988)(holding that the undersecured creditor is not entitled to adequaCe protection for thedelay in its foreclosure rights attributable to the autoixzatic stay).n~ See 11 U.S,C. §§ 502(b) (2), 726(a) (5) (2000).

1296 CO.RNLLL I AW KL''VIEW [Vol. 87: J 2~5

bankruptcy filing, the mortgage holder will receive considerationworth X800,000 on the effective date of the plan but will forgoX100,000 in postpetition interest. Thus, bankruptcy may reduce theundersecured mortgage lender's recovery on a present value basiscompared to what the lender would have received by pursuzng il:s statelaw rights.

G. Arguments For and Against Reorganization

We now discuss the fundannental question: Why should Coa~gresspernnit SERE cases to reorganize under Chapter 11?47 Some corxznnen-taeors have contended, or have adopted theoretical positions thatshould lead them to contend, that the Chapter 11 process in SAKEcases is inefficient compared to Che alternative of mandatory promptauctions.4~ A.ilocative efficiency, they argue, requires swift and ii~ex-pensive foreclosure i~z accordance with state law.``' These comnnenta-tors contend that permitting the borrower to file a Chapter 11petition inefficiently delays foreclosure, thereby imposing increasedcosts on secured creditors.5~' Secured creditors in turn pass theselosses on to all Uorro~vers in the form of higher interest rates.

Other commentators argue that bankruptcy law should permit in-terference with state law only if it solves a "common pool problem."~~In their view, bankruptcy la~v is necessary to prevent one creditor fromacting in its own. sel£ interest to the detriment o£ creditors as awhole.5~ For example, the law properly prevents a creditor with a se-curity interest. in valuable machinery of an insolve~~t manufacturingcompany from foreclosi~zg on its security interest and causing the liq-uidation o£ the debtor to the detriment o£ all other creditors. Thesecommentators argue that almost all SARE cases are two-party disputes

~7 See, e.g., Xoung, s24frra note 14, at 59 ("It is at least arguable that single asset realestate debtors do not belong in a reorganization proceeding at all."),48 See, e.g•., Douglas G. Baird &Edward R. Morrison, Banlzru~itcy llecision Making> 17 J.~..

~co;v. & Oxc. 356, 371 (2001).4J See Alex M. Johnson, Jr., Critiquing the Foreclosure Process: An Eco~aomic Af~1~roaclt Based

on tlae Ptcrrcdignaatic Norms of ]3ankru,~tcy, 79 Vw. L. REV. 959, 989 {1993). Johnson explains:

Tl~e ability of a lender to foreclose on a mortgage in an inexpensive andexpeditious manner is a key element of Che ex ante bargain struck betweencreditor aid debtor, a bargain that, allows the debtor to obtain a loan at avery attractive interest rate, at leasC compared with other forms of debt suchas personal Ioans.

Id.'~> Taken to its extreme, this argument supports prompt, strict foreclosure with no

right of redemption as Che anost efficient system. See, e.g., James Geoffrey Durham, In De-fense of SErict Foreclosure: A Legal and Econontir, Analysis of Mortgage Foreclosure, 36 S.C. L. Rev.461, 462 (1985) (concluding that "strict Foreclosure ... is the most efficient anethod of

foreclosure, a~1d is ec~uitahle and fair in almost every situation").51 See, e.g•., THOn~s H. JACicso~v, Txc Locrc A~i~ L~MtTS or BnNxizurrcy Lnw 19, 194-95

(1986).5z See id.

2002] ONF SIZE FITS SOME 1297

that involve only a debtor and a mortgage holder; therefore, there isno common pool problem, and there should Ue no bankruptcy case.~~Permitting a SAKE debtor to file for bankruptcy confers no benefitson a pool of other claimants, there being none, they argue, and it onlyimposes unjustified costs and delays on mortgage holders, resulting inhigher interest rates, fewer mortgage loan approvals,54 and the "with-holding from the marketplace property capable of producingvalue."~5 "The time spent in the Bankruptcy Court is wasteful andwithout any public benefit."'~ Therefore, proponents of this argu-ment support amending the Bankruptcy Code to bar SAKE cases fromreorganizing under Chapter 11.5

Contrary to the claim that the coxx~nnon pool problem is the soleor primary basis for evaluating the desirability of allowing SAKE debt-ors access to Chapter 11, three principal arguments, developed below,powerfully favor giving access to Chapter 11 so that SAKE debtorshave an opportunity to reorganize. First, Chapter 11 smoothes outmarket inefficiencies, particularly during massive real estate down-turns. Second, federal public policy supports giving property owners achance to save their investments. Third, macroeconomic and socialpolicies favor reorganization of SAKE debtors.

First, during broad-based financial crises, allowing debtors torestructure debts in Chapter 11 smoothes economic turbulence andprecludes tk~e downward spiral in real estate prices that can resultwhen mortgage holders simultaneously dump massive amou~~ts offoreclosed properties on the market. In addition, Chapter 11 func-tions in SAKE cases to snnooth out market inefficiencies caused by

5~ See, e.g•., Daniel ~. Draper, Stays of Mortgage Foreclosure—A Fra~iosal fns• Reform, 93BANI{ING I.J. 133, 13.5-3G (1976). Draper writes:

Although, in many cases, the insolvent debtor can adjust its fi~~ancial situation and eventually satisfy creditors, in our experience that is rarely, if ever,the case £or asingle-project real estate corporation. The presumption that"time will ]zeal" is simply not valid where the debCOr has virtually nothing toreorganize except a single mortgaged projecC .... Stays against securedcreditors of single-project corpor~itions z-arely increase the probability of re-organization and consequently cannot further airy policy aimed at enhanc-ing all opportunities for success by the debtor.

Yd.; Commercial and Public Sector Issues in Bankru~itcy: Hearing Before dhe Sul~comm. on Fcon. f~Commercial I azu of tlae House Comna. on t1ae,Judiciary, J 02d Cong. 250 (1992) (statement ofMichael F. Brown) ("When financial problems arise ...virtually the only creditor is themortgage bolder. Generally there is little or no trade debt or other associated debt.").54 Sec Commercial and Credit Heareng, su~~ra note 27, at 183 (J 991) (statement of James

W. Nelson) ("Tlie results of lenders' potential losses from single-asset foreclosure delaysare higher mo~•tgage interest rates to connpensate for loss, [and] a disincentive. for institu-tional Lenders to continue to invesC in commercial mortgages ....").55 Draper, sulrrce note 53, at 138.5e Icl, at 112.57 See e.g•., I NAT'L BANICI2. REVIEW COMi~I'N, $ANICI2UPTCY: THE NEXT TWENTY }(EARS

661 n.1678 (7.997) (citia~g authorities), available at littp://goviza£o.libz•azy,unr.edu/nbrc/reporttitlepg.html,

1298 CORNELL LAW REVIEW [Vol. 87:1285

state foreclosure systems.~~ Specifically, some state law foreclosure sys-tems are flawed because they permit lenders to seize property andconduct foreclosure sales without sufficient notice, resulting in artifi-cially depressed prices.5~ Although the Depression is long gone, "themodern nnortgage market is subjece to deficiencies that create similarmarket declines."60 These evils exist "[n]ot ...only in. time of emer-gency."6r Thus, many foreclosures result in nonconsensual sales at be-low market price. By contrast, Chapter 11 gives the property ownerthe opportunity to sell the property over a reasonable period of time.When debtors sell properties with their lenders' cooperation, the re-sulti~g orderly sales can increase value for the lenders and other cred-itors. Alternatively, Chapter 11 permits the property owner torestructure the mortgage through a consensual valuation under aplan supported by the mortgage holder or through a "market-tested"valuation in a contested plan con£irmation.62

Several commentators have endorsed these arguments. Based onhis previous writing,63 Judge Bu££ord testified that real estate reorgani-zation had its roots in the Depression and that Congress enacted it toprevent banks fronn owning most of the real estate in the nation.~4

58 See, e.g., Lynn M. LoPucki, Strange Visions in a Strange World; A Kelly to ProfessorsBruclley and Rosenxzueig, 91 Mtei-i, I... REV. 79, 100 (1992).

r'~ See Arthur ,J. I-Iughes, Reorga~tixution Under the Amendecl Banlzrulitcy ~lct, 13 No•i•ar,DAME I..Aw. 112, 114 (1937). Hughes writes:

Market values did not properly approximate the real values of Che proper-ties. The scarcity of purchasers generally enabled a few buyers to acquireproperties at ...far below the cost o£ the propexties .... To be forced tosell in such a inarkeC, was certain to result in a complete loss to the debtorand a substantial loss to the creditors.

Id.; see also Armstrong v. Csurilla, 817 P.2d 1221, 1223 (N.M. 1991) ("When property suU-ject to a mortgage or other Lien is sold in foreclosure proceedings, the buyer is usually themortgagee or other lien creditor and the price for which the property is ̀ bought in' issometimes significantly less than the property's fair market value."); cf. BFP v. ResolutionTrust Gorp., 511 U.S. 531, 539 (1994) (noting that property sold under the strictures offoreclosure is simply worth less than fair market value).

~o Robert M. Washburn, '1'Ite Judicial and I egislative Res~ionse to Price Inadequ~iey in Nlort-gag~e Far•eclosure Sales, 53 S. CnL. L. I2BV. 843, 851-52 & n.48 (1980) (citing Nat'l Bank v.Equity Investors, 506 P.2d 20, 43-44 (Wash. 19'73) (en banc)); see also Arthur ~. Wilmarth,Jr., The Lx~unsion of Stale Banit Pozue~s, the Federal Xes~ionse, and the Case for Pt~eserving tlae. DualBanking System, 5H FORDHAM L, Rcv. 1133, 1244 (1990) ("[During the late 1980s,] bankfailures in Texas have Ueen caused primarily by an excessive concentration of bank assetsin commercial loans related to real estate and energy ventures.").

61 D J. Farage, Mortgage Def ciency J~urlgment Acts an,cl '1'laeir Constitutionality, 41 Dic:tc, L.REV. 67, 67 (1937) ("[E]mergencies do expose Co the spotlight certain economic malprac-tices, which, in more prosperous times, flourish unheeded.").62 See Bank of Ain. Nac'1 Trust & Say. Assn. v. 203 N. LaSalle 5t. I.td. P'ship, 526 U.S.

439: (1999).63 See Samuel L. Bufford, What Is Right About Banl~rie~itcy Lazu and Wrong ALout Its C~ztics,

72 WnsH. U. L.Q. 829, 836-38 (1994) (arguing that bankruptc}~ law "prevents secured cred-itors from collectively starling a downward spiz'al of foreclosures and bank failures thatcould result in the failure of the entire economy").

6`~ S82 I NAT'I. BANICIt. RtiVIL'W COtv1M'v, szc1~rca note 57, at 680.

2002 ] O1VE SIZE FITS SOME 1299

For~xaer FDIC Chairman William Seidman testified before the HouseBanking Committee in 1990 that when bank .regulators force quick

sales v£ real estate owned after foreclosure, property values declineprecipitously.~~ Thus, when it considered the Bankruptcy Reform. Actof 2001, Congress was aware that orderly liquidations leave society bet-ter off.

Second, Chapter J l also implements zrnportant federal policiesprotecting ownership investments in real estate. Contrary to the asser-

tion that SAKE cases are two-party disputes, many cases involve the

interests of numerous owners who have invested in the real estate pro-

ject.6~ As a normative anatter, Chapter lJ protects general partners or

guarantors who rxiight be liable £or foreclosure deficiencies from the

risk of an unfair6'' or inefficient state foreclosure process. Asa conse-

quence, partners and guarantors can make efficient decisions ex ante

whether to invest in real estate projects.~~ Moreover, rr~inimizing £ore-

closure deficiencies has a beneficial second-order effect. The efficien-

cies of Chapter 11 reduce the tax recapture liability of partners in a

e~ See, e.g., 5cuart D. Root, F3ank Ca~iital, Asset Liquidation, and the Credit Crunch, 1993

CoLV~~. Bus. L. REV. 169, 182-83 (citing Federal Home I oan .Bank Board 1988 lleals: Hearings

Before tTte Ilo2ese Conan. on 13aniting, Fin. ~' Urban Affairs, 101st Gong. 28 (1990) (testimony of

William Seidman, Chairman, FDIC)) ("Congress ...seemingly ignored ...estimate [s] that

assets lose up to twenty percent of value when trey are taken over by the government for

disposition. A liquidation program involving hundreds of billions of dollars in assets is

thus bound to have. an adverse impact on values of assets held by institutions." (footnotes

omitted) ).

~E' Some cases also involve unsecured creditors, such as vendors, property managers,and tenants.

e'~ Although law-and-econonnics scholarship generally has steered clear of distribu-

tioiial issues, recently economic a~~alysis in the literature has attacked the propriety of mak-

ing fairness-based assessments. See, e.g., Louis I~aplow Sc Steven Shaven, Fairness Versus

Welfare, 114 HnKV. L. REV. 961, 1011 (2007.) (criticizing fairness-based assessments on theground eliat they depend "exclusively on the effects of legal rules on individuals' well-

being" and, as a consequence, "can make individuals worse off, that is, reduce social wel-

fare"). In tt►is Article, by "unfair," I refer to a state foreclosure statute that provides insuffi-

cient notice or auction procedures to produce a #air market price. See sources cited supra

note 59 and accompanying text. Some commentaeors might argue that the state foreclo-

sure system is part of the property owner's bargain when it obCains tl~e mortgage. Others

might reply that the property owners righC co file for Chapter 11 relief was a risk the

mortgage holder took when it made the loan.

~~~ Congress changed the risk/reward ratio for real estate investments in 1986 when ie

withdrew tax incentives to invest in real estate and c;nacted passive activity loss rules. See

Daniel S. Goldberg, Tax Sztbsidies: One-Time vs. Periodic: An Economic Analysis of tlae Tax Policy

Alter7aatives, 49 Tnx L. Rz~:v. 365, 3~0 (1994), But Chaptez- 11 iennains az~ important ~~art of

the risk/reward ratio by protecting owners fi~om immediate loss of their investments in the

event their }~usiness faces a liquidity crisis. See, e.g., Warren, su~iru note 36, at 357-58(describing Che policies o£ Chapter 71 as encouraging risk-taking behavior); LoYucki, su1rra

note 58, aC 100 (asserting that Chapter ll offers "the owners, and more importantly thecreditors, an alternative to putting ehe debtoz's assets ozi the auction block" when thedebtor faces a liquidity crisis).

1300 CORNELL LAW I~VIEW [Vol. 87:1285

debtor real esi:ate partnership, thus preventing governments fromreaping a windfall due to artificially low foreclosure prices.'`'

Third, macroecononnic and social policies also favor reorganiza-tion of SARE debtors. Granting SAKE debtors meaningful access toChapter 11 x~.ot only makes good economic sense, Uut it is also goodsocial policy. Generally, nnortgage lenders are the successful Uiddersat foreclosure sales.'70 Chapter 11 prevents undue concentration ofreal estate ownership into the hands of large financial institutions dur-ing economic downturns by facilitating reorganization and thedebtor's retention of ownership.'71 Moreover, some com.rnentatorscontend that Chapter 11 allows the bankruptcy court to consider equi-table, community, and other factors in ruling on a nnortgage holder'srelief from a stay motion.'72 For example, a court might consider that

~`~ Federal and state governments impose taxes on depreciation recapture and capital

gains arising from loan foreclosures whether ox not the loan is recourse. See, e.g., 26 U.S.C.§§ 1231, 1245, 1250 (1994 & Supp. V 1999)., The concept of a nonrecourse loan in bank-ruptcy is described Uy tl~e Supreme Court in Joltnsan v. Home Stale Bank, 507 U.S. 78, 86{1991) (defining nonrecourse loans as "agreements where the creditor's only rSghts areagainst property of the debeor, and not againsC tkie debtor personally" (citation omitted)).Taxpayers who dispose of property subject to nonrecourse debt in excess of basis typically

must pay tax on an amount of gain equal to the excess. See Comm'r v. Tufts, X61 U.S. 300,317 (1983). For a thorough description of hQw real property foreclosures create taxablegains, see Interlaotel Co. v. Commissioner, 81 "Z'.C.M, (CCH) 1809: (T. C, 2001), See also GregoryM. Stein, Tlae Sco1~e of the Borrower's Liability in a Nonrecourse RealTstate I oan, 55 Wnsx. & T..r~L. REV. 120'7, 1220 (1998) (discussing the tax benefits to limited partners when their part

nerships borrow on a noni-ecourse basis xather than on a recourse basis).

70 Basil H. Mattingly, The Shift from Poruer to Process: A Functional Afr~ri-oaeh to ForeclosureI azu, $0 Mtut~,. L. Rev. 77, 101 (J.996) (seati~~g that lenders rely nn foreclosure "to controltheir collateral, to cixe the borrower out of the title picture" Uecause they "gez~,erally antici-pate being the purchaser at foreclosure sales"). "`Typically, leaders are the successful bid-ders at foreclosure sales. After buying the property the lenders take the property into theirportfolios.... [TJhey [then] hire real estate agents to locate prospective purchasers."' Id.ac 101 n.104 (quoting Maury B, Poscover, A Commercially Reaso~zable Sale Under Article 9:Com~rnercial, h'e~rsonable, and .Fair to All Involved, 28 LoY. L.A. L. REV. 235, 2A6 (1994)).

'71 I'or example, during the 1980s, government regulators seized several savings andloan associations and forced most of them to simultaneously market and sell the real estatethey owned. As a result, the market was flooded with real estate inventory and prices plum-meted. See Goldberg, su[rra note 68, at 341 ("[P]rices declined further and the marketbecame flooded with available real estate.").

72 See, e.g~,, Ray~x~ond T. Nimz~er, Real Estate Creditors and the Automatic Stay: A Stiedy inBelaavioral Economics, 1983 Ariz. ST. LJ. 281, 281 (1983). Niminer writes:

A secuxed creditor ~vho can remove the stay may gain a substantial eco-nomic bex~efit. Depending on the relationship between the secured collat-eral and the debtor's overall estate, denial or delay of foreclosure m:ay bevital to ultimate completion of a plan £or relief .... [rconon~ic and fina~~-cial] Factors a~•e not the only considerations that courts apply.... The res~rltis a general balancing of equitable factors ...that is significantly morecomplex than the pure economic evaluation often suggested in theliterature.

Id.; ,see ~clso Karen Gross, faking Community Interests into Account in Bankru~~try: An Essay, 72WASH, U. L.Q, 1031 (7.994) (arguing that courts should take cozx~mixnity interests into ac-count in bankruptcy).

2002] O1VE SIZE 1{ITS SOME 130].

"[m]any foreclosures occur in inner-city neighborhoods occupied bylow-income groups ... fac[ing) unemployment in an economic down-turn ... [and] are thus more likely to default on their mortgage loansand less able to avoid foreclosure."73

It appears that these three argurr~ents won out over law-and-eco-nomics arguments to the contrary. For reasons that were not appar-ent in congressional debates concerning the 2001 Amendment,neither Congress x~or the nnortgage holders embraced arguments toexclude SARA debtors from Chapter 11.74 Perhaps they ~cvere awarethat within the realnn o£ econoxxxics (in opposition to the efficiencyarguments identified at the beginning of this subpart}, some com-m;entators believe that Chapter 11 reorganization promotes allocativeefficiency as compared with foreclosure under state law.'75 Or perhapsthey accepted the above three arguments ix~ response to the efficiencyand common pool problems. State law foreclosure is more efficientthan Chapter 11 under most market conditions. When real estatemarkets are turbulent, however, ouz experience with the Depressionteaches us that state law foreclosure imperils both borrowers and lencl-ers. Moreover, we should not forget that politicians are responsiblefor legislation. Many politicians consider issues of fairness and equitythat generally fall outside the realm of allocative efficiency.76 As iden-tified above, these concerns could well support a political decision toallow SARA debtors access to Chapter Y 1. As discussed below, that iswhat the politicians did.

7~ Washburn, ,su1ira note G0, at 853.7~ Some witnesses made arguments based on efFciency to urge re}~eal of the °~4 mi!-

lion cap, but not to support an outright ban on SAKE deUtors' access to Chapter 11. SeeBankru~itcy Amendments of 1997; and Bankruptcy Law ̀L'eclanical Corrections Act. of 1997: Hete~zng

on H.R. 764 and H.R. 120 Before tlae Subconzna. on Commercial f~' Admin, I aru of tlae Hoarse Conam.

on the Jicdiciary, 105th Long. 106-09 (1997) [hereinafter Banl~rzc~itcy tlmendments Hearing](statement of Donald R. Ennis) (asserting that repeal of the ~4 million cap is necessary "topermit the efficient operation of Che single asset provisions and ehe fulfillment of theirpurpose") .75 contrary to the argument that allocative efficiency requires strict Foreclosure with-

out redemption, econonnic data demonstrate that mortgagor protection laws "may indeedpromote economic efficiency." Michael H. Schill, An economic flnalysis of Mmtgagar Proteo-Lion. L~~rur, 77 V~. L. 12~v. 489, 497 (1991). According to Schill, "[V]iewer] from an ex anteperspective, inoz-tgagor protections may promote, rather than impede, economic efficiencyby functioning as a lbrin o~ insurance against the adverse effects of default and foreclo-sure." Icl. at 538. This Article does not attempt to resolve which commentators are correct,whether state law foreclosure systems are pre£eraUle to Chapter X1, or which group has theburden of proof in evaluating comparative economic efficiencies. Rather, zt is based onthe assumption that Congress has adopted Chapter 11 as a federal alternative to state lawforeclosu~~e.7f See &plow 8c Shaven, s~i~rra note &7, at 10].1 (argttin~ that economic analysis should

give no weight to i~otioi~s of fairness).

1302 CORNELL LAW REVIEW [Vol. 87:1285

D. The Politics

Those interest groups that pushed for special treatment of ~SAREdebtors could have instead called for their exclusion. Since argu-ments for the complete exclusion of two-party disputes were made atthe time of both the 1994 and 2001 amendments, why did the lendingindustry not push £or an outright exclusion of SARA cases from bar~lc-ruptcy? Perhaps their lobbyists counseled against trying to overturn afederal policy that is over sixty years old. Alternatively, it is possiblethat mortgage holders wanted their borrowers, in some cases, to haveaccess to Chapter 11.

In cases in which tine to the property is clouded or the propertycontains toxic waste, for example, mortgage holders prefer to use thebankruptcy court to their o~vn advantage.77 Chapter 11 £ally con-strains the property owner's activities, and the property may be cle-aned while the mortgage holder avoids any liability arising out ofownership resulting from foreclosure, By permitting property ownersto reorganize under Chapter 11, mortgage holders get the best ofboth worlds.

However, the lenders' attraction to Chapter 11 is narrow: Theywant all of the benefits of bankrupi:cy and also control over the pro-cess. For example, they do not want the debtor to be able to restruc-ture secured debt without the lender's co~~.sent. Moreover, lendersare not content to receive these benefits in small SARL, cases; theywant them in all SARE cases.'78 Thus, they influenced the National

Bankruptcy Review Commission to make a recommendation to Co~~-

77 Lenders may realize another subtle benefit of Chapter 1 X. Mortgage holders whodo not want to foreclose on defaulted real properties may use the aucornatic stay of borrow-ers' Gllapter 11 filings to accomplish that objective, even if the mortgage holders' ~overn-menC regulaCOrs would pre#'er immediate Foreclosure. During a borrowers Chapter llcase, the automatic stay legally prevents foreclosure unless the lender obtains relief fi-omthe stay. Lenders who do not want real estate assets on their books can fail to seek relieffrom the automatic stay or delay the process. See Sutherland, su1~ra note l9, at 217 ("T'hemortgagee has ordinarily used every resource to encourage the debtor to keep up kzis inter-est and taxes, and comes to foreclosure only when the case is hopeless. The great lendinginstitutions are reluctant to load themselves with foreclosed real estate ....").

~~ See, e.g•,, Bankraa~~tcy Amendments Hearr'ng, sZC1rra note 74, at 118, 12J —22 (statement ofJill M. Sturtevant, Assistant General Counsel, Bank of America) ("[T'he A~ne~-ican BankersAssociation] scro~igly supports the ...provision ... strik[ing] the ~p~! million debt cap .. .contained in the definition [of] ̀sixigle asset real estate."' (emphasis omitted)); Oversight ofthe National 13r~nliru1~tcy Reuieru Commission l~~ort: I-Iea~zng Before the Subcomm. on Acl~nin. Over=siglct f~ tlae Co2crls of the S. Comm. on 1.heJudiciary, 105th Cong. (1997) {statement of John A.Gose) [hereinafter Gose Testimony] ("No rational correlation exists between Che size of asingle asset real estate bankruptcy ai~.d the complexity of that transaction. A cap, whichpresently exists in the Bazxkruptcy Code, is purely arbitrary."), at 1997 WL 65J242.

2002] ONL SI7,E FITS 5'OME 1303

gress to amend the law,7`' and they financed lobbyists to shepherd thatamendment into la~v.~0

It is not surprising, therefore, that in passing the 2001 .Amend-ment, Congress nominally retained access to Chapter 11 for SARAdebtors while sharply reducing the meaningfulz7ess of that access.The result is a proposed law that pernnits debtors access to Chapter X 1,but under such tight time restrictions that, after ninety days, thedebtor's Functional ability to remain in Chapter 11 usually will be atthe complete discretion of the mortgage holder. Moreover, unlikecuxrent law, the restrictive procedures of the 2001 Amendment wouldapply to single asset real property projects of all sizes without regard tothe dollar arx~ount of the mortgage. With this background, we areprepared to examine closely the 2001 Amendment as a prelude todetermining whether Congress made the right choice in elixx~inatingthe cap.

IITHE ̀~OO~ AMENDMENT EXPLODES TE-IE CAP

A. The Rationale for Congressional Action

The Bankruptcy Reform Act of 2001 paroposes to abolish the ~4million cap in the definition of SERE based a~1 argunnents made atcongressional hearings that aone-size reorganization procedure couldfit all SAKE Uanlcruptcy cases.~l Tt is the author's experience that lab-

7~ At the instigation of the author, a majority oP the bankruptcy commissioners alsosupported an alternative recommendation that would have raised the SAKE cap but noteliminated it. See ]. NnT~L BANICR. RLVCL:W COMNi., supra note 57, at 684.~~ See, e.g., Bc~nl~ru~itey I~nforrrc Art of 1999 (Part I!): Hearing on H.li. 833 Befvre t7ae SzeL-

com.na. on. Commercial ~' tl~lmi~a. I.aru of the House Go•~n~n, on the Ji~dicira~y, 106th Cong. 5-14(199J) (statement of George J. Wallace, nn behalf of the Consumer Bankruptcy RefozmCoalition); Bct~alzrtt~itey Reform Act of 1998 Part I• Hewing on H.R. 3150 Before the S2tbcomm. onGom~nercial E~' Adntin. Lazu of tlae House Comm.. on tlae Judiciary, 105th Cong. 25-28, 38-40(x998) (statement of Lloyd N. Cutler, on behalf of the Bankruptcy Issues Council); Ba~alz-rta~tcy Reforrn Act of 1998; Res~~onsiGle Borrower Protection Act; and Consume• Lenders tend Barroru-e~s Barak-ria1~Gcy Acco•tcntraLiliGy Art of 1998 Pccrt II: Her~•~ting• on H.R. 3150, H.R. 2500, and H.R.3146 13e%ore the S2cbconi~na. on Co~~tnaer•cia.l f~' Adnti~z. Lazu of th.e House Comm. on tlae Judiciary,105th Cong. 56-63 (1998) (statement of George J. Wallace, on behalf o£ e11e AmericanFinancial Services Association).

~1 See sources cited sic1~ra note 78 and accompanying Cext. One congressman charac-terized the repeal of the ~4 million cap as necessary to cure an "injustice" stemming "froma last minute decision that was made in the 103rd Congress, which placed an arbitrary f~4million ceiling on ehe single asset provisions of the bankruptcy reform bill. The effect hasbeen to render investors helpless in foz'eclosure on single assets valued at over• $~4 millioa~."See 145 Cotvc~. Rrc.. H2713 (daily ed. May 5, 1999) (statement of Rep. I{nollenberg). Inex-plicably, in the pending Bankruptcy Reform Act of 2001, Congress adopted exactl~~ theopposite x-ation~ile in expanding the deUt threshold fi•oxn $2 million to ~3 million in thede£'inition of sn~.all business debtors for the purpose oi' segregating small businesses fromlarger businesses. Sec, Bankruptcy Re£orm Act of 2001, H.Tt. 333, 107th Cong. §X32 (a)(2001) (pz•oposing to amend the definition of "stxxal] business debtor" in § 101(51)(D) ofthe BankrupCcy Code to cover busi~~c:sses that have "aggregate nonco~iCingene, liquidated

].304 CORNET L LAW REVIEW [Vol. 8'7:1285

byists fox lenders convinced Congress that a real estate case is a realestate case is a real estate case, whether it is an apartment house or theWaldorf Astoria Hote1.~2 Some witnesses told Congress that it shouldrepeal the ~$4 nnillion cap because large properties have the samennaintenance, tax, and recapitalization probler~as as small properties.8~They also stated that repeal of the ~$4 million cap was necessary "topermit the efficient operation of the single asset provisions and thefulfillment of their purpose."84 Other witnesses and comnnexztatorstook the position that some form: of a cap ~evas appropriate, but had nohard data to support their claiz~s.~' .Although a few witnesses sug-gestecl banning SARE cases from Chapter 11 altogether, others saidChapter 11 played an important role in SAKE cases.

Some witnesses unsuccessfully argued in support of retaining the~$4 million cap and treating large SAKE debtors the same as otherChapter 11 debtors.~~ They argued that separate treatment of allS1~RE debtors from other debtors would induce lenders to force bor-ro~vers to incur transaction costs to form new single asset entities inorder to finance each pxoperty, even. if the same real party in interesto~rned the properties. Thus, if a manufacturer seeks financing forconstruction of a $~50 xrnillion plant, a rational lender will require themanufacturer to form a single asset cox~apany to hold title to the realestate and become the borrower. The lender may force the rnanufac-tu~ ex to guarantee the debt. As a result, the manufacturer will notavoid liability on the loan, and will incur the transaction costs of form-ing the single asset company and maintaining separate tax, account-ing, and legal records. Moreover, in the event of insolvency of several

secured and tYnsecured debts .. , in an amount not more than $3,000,000"), avc~ilaGle cathttp://thomas.loc.gov; Bankruptcy Reform Act of 2001, S. 420, 107th Cong. § 432{a)(2001) (same), «v~eilt~l~le at http://thomas.loc.gov.

~z See In re Penn Gent. Transp. Co., 354 F. Supp. fill (E.D. Pa. 1972). After the 2001Amendment, if the ground leased was real propez•ty held by a SA.RF, debtor, Y1 U.S.C.§ 3G2(d)(3) would apply.

~~ See sources cited su1yrri note 78.~4 Ba~zkrzcptcy ~lmend~~nents Hearin; su~ira note 7~, at 107 (statement of Donald R.

Ennis).

Kra Sen., e.g., tid, at 46 (statement of Kenneth N: I~lee, Chairman, Committee on Legisla-

tion, National Bankruptcy Conference) ("I would have to think a $~10 million limit would

brixzg in the lion's share of the projects ...."); Lawrence Ponoi•off, Ilae Dacbious Role ofPrecedent an the west fm• Fi•>st Principles in the Reform of the Bcrnkru~itcy Cocle: Some Lessons from

the Civil I,rczu rind Rerelist '1'ra~litions, ~4 ANi. B.aNicK. L J. 173, 195 (2000) ("'Wisely, until now,ehe definition of ̀single asset real estate' has been limited to debtors with below a certainmaximum level of secured debt ...."). Aftez• tlae congressional hearings, Professors War-ren and Westbrook analyzed hard data and concluded that the ~4 million cap alreadycovers 72% of the SAKE cases and raising die cap co X15 million would capture 9~% of thecases. See ElizaUeth Warren &Jay Lawrence Westbrook, Tinancit~l Characteristics of B2uiyaessesin B~r~zk•~z~~~tcy, ~I3 ANT, Br1NKR. L, J. X99, 542-43 (1999).H~ See, e.g., Brcnli-rec1~tcy Amendments Flearing, szc~na note 74, ac 37, 46 (statement aa~d

eestimony of Kenneth N. Klee, Chairman, Committee on Legislatio~~, National Ba~~kruptcyConference).

2002] OIVE SIZE FITS SOME 1305

related piojects, instead of the manufacturer filing for bankruptcy forone company that owns several properties, the manufacturer will file aseparate bankruptcy petition for each company that holds a troubledproject, thereby paying multiple filing fees and inc~.irring the costs ofmultiple bankruptcy administrations.H7

In this light, it is reasonable to question ~vhy Congress abandonedthe line it drew in 1994. Was the change occasioned by lobbying ~res-sure from secured lenders, or did circunnstances change after 1994?ti11as Congress wrong in enacting the cap in the first place in 1994?Certainly the shared experience that led Congress to adopt the $4million cap in 1994 suggested that the group of larger SARE cases hadmore complex debt structures, greater capacity to service Chapter 11administrative expenses, aizd a greater likelihood of confirming aplan.$$ That is why Congress enacted special rules only for smallerSARA debtors. Anecdotal testimony led Congress to believe thatsmaller deUtors, for the most part, had simple debt structures, littlecapacity to service Chapter 11 administrative expenses, and no reason-able likelihood of con£irnning a plan. For the small SAKE debtors, itmade sense for Congress to pretermit the Chapter 11 process.

The sanne was not true, however, fox larger SAKE debtors in 1994,and it remains untrue in 2002. If there is a reasonable likelihood that,as a group, Iarge SAKE debtors will be able to confirm Chapter 11plans, what ratioi~.ale justifies subjecting these debtors to the stricturesof § 362 (d} (3) of the Bankruptcy Code? Indeed, if the data show thatmost large SAKE cases have a reasonable possibility of confirming aChapter 11 plan, it makes more sense for Congress to raise the ~4million cap to a specific dollar sum than to abandon it altogether.Perhaps Congress believed that if the cap Functioned well for snnallSARE debtors, it should extend it to all SAR.E debtors.

87 This strategic behavior certainly is one downside of the pending Bankruptcy Re-form Act of 2001, which allows lenders to opt nut of the regular Chapter 11 rules by requir-

ing borrowers to connpartmentalize real property assets. Another theoretical by-product of

the proposed Acc is that it should reduce monitoring by unsecured creditors. Unsecuredcreditors wi11 not likely pay atte~~tion to SAT2E cases if secured lenders will dominate and

quickly foreclose or receive assets as interest payments. In the author's experience, how-

ever, unsecured creditors seldom rno~~itoxed SARE cases even befo~•e the Act was proposed,

becarxse they had little at stake individually.

$H See, e.g., Lynn M. Lol'ucki & Sax•a D. Kalin, llaeTailure of Pxiblic Conz~~u~ay 13ank~-xc~~tcies

in Delazacere and Neu Yarh: Em~iirical Evidence of re `Rcice to tlae Bottom'; 54 V~a~n. L. RLV. 231,

256 (2001) (showing an extremely high confirmation rate for large public companies fi-om

1989 until 1997); I ynn M. LoPucki 8c William G. ~1rl~itford, Patterns 7n the Bu~alti~~~~tcy Reor

ganiz~itio~. of~7 a~r~re, Publicly Held Com~~anies, 78 CoRNr~.i. L.. Rev. 597, 600 (1993) (reporting a96% confirmation i°ate for large, public companies).

130G CORNET L LAW REVIEW [Vol. 87:1285

B. Predicted effects of Blowing Up the Cap

Whether or not Congress justifiaUly proposed to explode the ~4million cap, if the proposal becomes law, parties in SARE cases willhave to adapt to those changes. The new reality for large BARE debt-ors will be that they will be subject to lenders' threats to bring, andactually file, motions for relief fronn the automatic stay under§ 362(d) (3). How will this change in leverage affect the way ChapterX 1 functions for large SAKE debtors? Certainly it will be unreasonablefor many large SAKE debi:ors to file a plan ~vithin ninety days after theorder for relief To be sure, the court can extexa.d this time for"cause,"H' but why should the large SAKE debtor have to bear the cost,burden, and uncertainty o1' bringing such a xnotiorz? The cost ofbringing a motion is inevitable and not recoupable. The burden ofproving the "cause" for an extension is on the large SAKE debtor,unlike all the other large debtors who have a minimum 120-day exclu-sivity period within which to file a plan and do not face automaticforeclosure if they fail to File ~cvithin that period. The uncertaintyabout whether the judge will grant the extension motion is obvious.Many judges have displayed open hostility toward SA12E debtors.~0

Of course, the debtor has the theoretical option of commencingpayments to the mortgage holder. But many SARE debtors are illiq-uid.J1 The ,BARE debtor might be cash poor because the debtor hasnot completed the real estate project, because the debtor needsmoney £or repairs, maintenance, or renovation, or because a downnnarket has created large vacancy rates. Moreover, in most SA12Ecases, the mortgage holder has a lien on the rents.'z Under current

~`~ See sources cited su~rtr note 9.`~~ Generally, judicial hostility is evldene when a judge cl~aY•acterizes tl~e SARA deUtor

as having •filed its bankruptcy petition "in bacl faith." See, e.g., Pac. Firse Bank ex rel. R.T.Capital Corp. v. Boulders on the River, Inc. (In re Boulders on die River, Inc.), 164 B.R. 99,103 (B.A,P. 9th Cir. 1994) ("Bad faith exists if' these is no realistic possibility of reorganiza-tion and the debeor seeks merely to delay or fi•ustraCe efforts n£ secured creditors.");United Say. Assn v. Timbers of Inwood Forest Assocs., Ltd. (In. re Timbers of Inwood ForestAssocs., L.td.), 808 r.2d 363, 384 (5th Cir. 198'7) ("To the extent Chat chi debtor in bank-ruptcy can prevent tl~e secured creditor f►•om enforcing aes rights against collateral whilethe debtor benefits from. the creditor's money, the debtor and 11is unsecured creditorsreceive a windfall at the expense of the secured creditor."), ~ff'd, 484 U.S. 365 (l98$).Courts often dismiss debtors' Chapter 11 petitions when they are filed in "bad faieh." See,e.g., Albany Partners, Ltd. v. Westbrook (In ye Albany Partners, Ltd.), 749 F.2d G70, 676(11th Cix. 1984) (a£firnzing a lower court's annulment of a stay); Singer Furniture Acquisi-tion Corp. v. SSMC: Tnc. N.V., 254 B.R. 46, 60 (M.D. Fla. 2000); .ree ~elsu Xra re Pac. Rin-~ Invs.,LLP, 243 B.R. 768, 7'73 (D. Colc>. 2000) (rejecting "the argument that the ability to reor-ganize precludes dismissal for bad faith."),

~1 See LoPucki, su~rr~a note 58, at 100; sow~ces cited sz~~nrc note 36.`~~ In some SAI2F, cases, the mortgage holciea• has an "absolute assig~lment" of Che rents

whereby the mortgage holder• owns the i•ent~s until the inortg~age is paid. See, e.g:, Great W.

Life Assurance Co. v. Rothman (1'n. re Ventura-T.ouise Props.), 490 F.2d 1141, 1143-4~ (9th

Cir. J.974) ("[A]n ag~•eemcnt can provide for an absolute assignment of'rents upon default.

2002] ONE SIZE FfTS SOML X307

law, mortgage holders have persuaded some courts that rents are ad-ditional collateral that the la~v must proi;ect separately, and that theyare unavailable to protect a mortgage holder's lien on a real propertyproject.~3 One bene~iciar provision of the proposed Bankruptcy Re-form Act of 200]. makes cents available to satisfy the deUtor's paymei~eobligation under § 362(d) (3) of the Bankruptcy Code.J4 But in manycases, the net rents will be insufficient to service the debtor's payment

`It has been held that such a provision, rather than pledging the rents as additional secur-ity, operates co transfer to the mortgagee, the nnortgagor's right to tUe rentals upon thehappening of a specified condition."' (quoting Kinnison v. Guar. Liquidating Corp., 115P.2d 450, 453 (Cal. 7941)). Although beyond tl~.e scope of phis Article, discussion of rentshas created a large body of literature, Not less than sixty-four law review articles containthe word "rents" in their titles. Of these, no fewer Chan seventeen also mention 1'n re 'Ven-t2aru-Ionise. See, e.g., David Gray Carlson, Rents in B~cnkrufitcy, 46 S.C. L. Rev. 1075, 1Y04(1995) (discussing In re Ventura-I ozcise for the proposition that judges routinely authorizeforfeitures upon default and allow secuz•ed parties Co collect rent}; Julia Patterson For-rester, AUniform and More ,Rational A~~irouch to .Rents as Secaerity fvr the Mortga~~e Loan, 46RuTC~RS L. Rev. 349, 379-82 (1993) (discLissing the trend in the treatment of absoluteassignment of rents cases); Patrick A. Randolph, Jr„ 4Vlae~a Should Bunkr~c~itcy Courts RecognizeLenders' Rents Interests? 23 U.C. DAV~s L. Rev. 533, 841-45 (1990) (discussing the condi-tional present assignmez~t theory as adopted in In re CTentaa•ra-Louise); John C. Siemers, TheMortgagee s I ien Against Rents, 25 ~'~~:x. 'TEC;x L. Rcv. 873, 892 n.70 (1994) (acknowledging 1'nre ~/entura I o2iise in a footnote); Joanne N. Davies, Note, FNMA v. Bugna: California Assign-ment of Rents Provision anti tlee Im~iact of the Bankru~tey Reform Act of 1994, 31 Lov. L.A. L. REV.1453, 1466 (1998) (discussing the "contradictory and confusing" case law surrounding theprotection of a lender's security interest in postpetition rents); Sandra Elzerman, Cotn-ment, Inte~~ests i•~t Collrcterully Assigned Rents and Profits Under the I3unitru~itcy Code, 22 Hous. I..Rev. 1251, 1265 n.101 (1985) (acknowledging In re Ventura-Louise in a footnote).

~3 See, e.~., In •re 499 W. Warren St. Assocs., Ltd. P'sliip, 142 B.R. 53, 56 (Bazikr.N.D.N.Y. 1J92) (stating that "a secured cz•editor holding both a mortgage securing a debton a parcel o#'real property, and a perfected security interest in rents derived therefrom,holds two distinct interests," and cliscussin~ cases laying out the contours of this approach);see also ,Jol1n Hancock Mut, Life Ins. Co. v. Madera Farms P'ship (In re Madera FarmsP'ship), G6 B.R. 100, 103 (B.A.P. 9th Cir, 1986) ("It is clear that Che rents are additionalcollateral."); In re Landing Assocs., Ltd., 122 B.R. 288, 296 (Bankr. W.D. Tex. 1990) (con-siclering• the value of the mortgage securing a debt nn a parcel of land as separate from thesecurity interest in the rents derived from it); Mortgage Guara~~tee Co. v. Sampsell, ].24F.2c1 353, 356 (Cal. Ct, App. 1942) ("There can be xzo question but that the assignment ofrentals in the deed of trList constituted additional primary security with the real propertydescribed in the deed of trust and the personal property described in the chattel mortgage." (citation omitted)).

J4 See Bankruptcy Refoa-m Act of 2001, H.R. 333, 10'7th Gong., ~ 444(2) (2001); Bank-ruptcy Ref~rin Act of 2001, S. X120, 107th Cong., ~ ~~14(2) (2001). Section 444(2) wouldamend 11 U.S.C. § 362(d)(3)(B) to preclude relief from the stay antler § 362(d)(3) if:

(B) file det~to7- leas commenced inonCl~ly payments that—

(i) may, in the deUtor's sole discretion, z~otrvithstanding section3G3(c) (2), be made from rents or other income gexierated before orafter the commencemei~l of the case by or fi-om the property to eachcreditor whose clai►n is secured by such real estate (other than a claimsecured by a judginenc lien or by an unmatured statutory lien); and(ii) are in an amount equal to interest aC the then applicablenondeiault contract race of interest nn the value of the creditor's inter-est in the real estate; ... .

H,R. 333, ~ 44~(2)> S. 420, § ~k44(2).

1308 CO.R.NELI. LAW REVIEW [Vol. 87:1285

obligation in full. Thtxs, in many SAR.E cases, the debtor's option tocomnnence making payments will be unrealistic.

If the debtor cannot file a confirmable plan within the fast trackof ~ 362 (d) (3), commence making payments to the mortgage holder,or persuade the court to grant an extension of time, then the moregage holder is effectively in complete control of the Chapter 11 pro-cess. If the property has a feature, for exaxxiple eanviroaiznental waste,such that the mortgage holder might benerit by leaving the propertyin Chapter 11, the mortgage holder can grant an extension o£ tinne orfail to foreclose following relief from the stay. Alternatively, if the bor-rower faces tax problems in the event of Foreclosure, the lender canthreaten foreclosure to extract a contribution o:f new equity into theproject Co reinstate the loan and restore it to a performing asset onthe lender's books. On the other hand, if the property has potentialupside and the mortgage holder desires to capture this upside for itsown benefit, then the mortgage holder gets relief from the automaticstay and the right to foreclose on the properey. In essence, the Chap-ter 11 case is over. Although this might be good news for the mortgage holder, it is bad news for the property owner who loses theopportunity to reorganize.

IIIDaT~. rRO~ SARE C~.rT~:n 1 X C~sEs

A. Methodology

Talk is cheap. It is easy to criticize Congress for failing to developdata concerning the operaCion of SAKE cases before it proposed sig-nificant changes, but it is much harder to develop those data than tocriticize Congress for failing to do so. This is especially true .Cor schol-a~ s and others who work with linnited access to the underlying dataand limited means to Fund the needed research. Given the impor-tance of bankruptcy law and the constitutional requirement that anyfederal bankruptcy law be unifornn,J5 it is astounding that Congresshas not developed better bankruptcy data on which to base its legisla-tive decisions. For example, there is no national database of bankruptcy court records; bankruptcy courts compile and store theirrecords locally. Furthermore, the Administrative Office of the U.S.Courts does not collect separately-recorded data nn SAKE cases. Thismeans that the resources necessary to draw a national sample of S,AR.Ecases would be beyond the reach of a single researcher.

Faced with the prospect o£ cursing the darkness or lighting a verysmall candle, however, X decided to study what I could. I drew twosamples of data: The first was a national sample of all reported Sl~TtE

~r> ,See U.S. CovsT. art. I, ~ 8, cl. 4.

2002] o~ srzr; rxTS sow 1309

decisions augmented by data ox~ unreported SURE cases sent to me bylawyers in response to a questionnaire. The second extracted SARAdata from the files of all Chapter 11 cases administered by a singlebankruptcy judge in Los Angeles. I refer to the first sample as the"National" data set and the second sample as the "L.A." data set. I alsocombined the National and L.A. data sets into a "Combined" data set.

I began this research by collecting every published bankruptcycourt opinion dealing with a SAKE Chapter 11 case under the B~.nk-iuptcy Gode, despite the shortcomings of such a database. Publishedopinions inay be grist for law school classes, but they are not randomsamples of all the cases decided. Indeed, the fact that an opinion ispublished is a £air indication that something is aberrational in thecase. This defect afflicts any study o£ published opinions, although i~-ithe bankruptcy area it is ameliorated by the fact that trial courts—notjust appellate courts—publish their decisions. That di££erence makesa database drawn from bankruptcy court opinions somewhat closer toa representative sample and the underlying reality, although the casesin which there was a sufficient dispute to prompt a published opinionare obviously somewhat different from a perfect cross-section of all theunderlying cases. The cases that result in a written opinion may in-volve more money, more contentious creditors, ox rxaore aggressive

lawyers. Despite these limitations, however, a database consisting ofall published SA12F. cases, dominated by cases from. the bankruptcytrial courts themselves, can shed some light on the operation of real

estate Chapter L 1 cases.

Therefore, in. order to test the reasonableness of abolishing the~$4 million cap, T studied every reported SARE Chapter 11 case frown

October 1, 1979 through DecemUer 31, J.997 to extx'act the followingdata, among others:~~

~f' Because I am not recommending a specific debt limit for Congress to adopt, I clidnot develop a specific dollar value or adjust debts and property values for the data set toconstant dollars for a specific base year. My h}'pothesis is that adjusting the data over timeis an appropriate fine-cu~iing of my ix~etliodology, lnit unnecessary co support die trendszdentiiied in this Article. To snake certain, 17owevea•, that the data are z~ot distorted byinflationary differences, the debts and property values were recomputed using an inflationadjustment based on the year of the bankruptcy filing. It is possible, o£ course, that the

mortgage debt ox- property valuation was made a year or two after the filixzg, Uut this adjust-ment helps to eliminate most oP the inflationary effects. O£ the forty-five cases in the Na-tional data set, only thirty-two have information on the year in wl~icl~ ehe Chapter 11

petition was filed. It appears, however, Chat most of the remaining• thi~~t.een cases were £sled

between 1987 and 1993. I used 1990 as a proxy-valuaeion year for these data and usedactual filing years for the thirty-two cases in which Y had filing data. I adjusted die valuesusing the Consumer Price Index, and re-ran the regression. The resulting Nagelkerke R'-(see i~afra note 154) is very similar (.44) compared wieh the pre-adjustment Negelkea•ke RL(.~k2): the coefficients ai•e almost. identical, and the significance levels improve. Tt~e 1rvah~efor property value is .0043 (compared with <.O1) and £or Che value-to-loan ratio is .0184. Inruin, inflation does nc>t appear to have a measurable effect on the statistical analysis.

13J 0 CORNET L I AW I~iEV7EW [Vol. 87:1285

• type of property;

• valuation range of tl~ e property;

~ whether there was an out-of-court sel:tlei~nent, cram down., or con-sea~sual plan;

•whether maintenance and taxes were current pre-workout orprepetition;the terms of the senior and any junior indebtedness pre- and postrestructuring or plan. confirmation; and

• any treatment of the old equity under the plan.

In total, the database contains sixteen categories of information per-taining to various factual aspects of the cases.

To gather some in£orrn.ation about across-section of SAKE casesthat did not result in a published opinion, I developed and circulateda questionnaire to 302 bankruptcy lawyers. Of the bankruptcy special-ists selected, I chose ninety based on my own experience and 212from a bar association's membership list.97 The questionnaire askedeach lawyer to provide the same kinds of information on all SAKEcases in which they participated since October J , 1979.y8 As describedbelow, this permitted expansion of the initial thirty usable cases'9 inthe database by another fifteen cases.lo°

Many of the reported decisions and a few of the questionnairesdid not contain. complete data in every category. To fill gaps in thedata., I asked attorneys involved in the cases ro provide additional in-formation.lol The database included 152 cases with sufficiently com-plece information for an extended analysis. Those 152 cases included120 bankruptcy court decisions, thirteen appellate court decisions,and nineteen cases generated from. the questionnaires, x epresenting

~7 Specifically, I sent eighty-nine letters on February C>, 1998, fifty-three letters onA~~ri19, 1998, sixty-four letters on April 16, 1998, and ninety-6ve letters on Aril 28, ]998 tobankruptcy specialists known to me and to members of the ABA Business Bankruptcy Com-xnittee. I also sent one specialist the questionnaire via e-mail. In response, I received ques-tionnaires describing sixteen SARL' cases. The z•esponse rate is low probably due to thetime and expense required of respondents to assemble the requested information.~H I extracted [he data from the case law and questionnaia•es and entered it into a

Microsoft Excel spreadsheet. I have reproduced a sample questionnaire i~nfrcc in AppendixB.9~ T define the terns "usable case" to mean a case with suffciendy complete infornna-

tion for axi extended scatisticai analysis.10~~ It is possible that tl~e low respoiase rate procliicing these fifteen cases could lead to

sample Uias. Confirmation rates £or these cases are significantly l~igher than the reporteddecisions. This disparity may reflect a judicial bias to wriee and publish opinions denyingconfirmation, or it may reflect a bias on the part of attorneys in submitting data on con-tirmed cases in response to my questionnaire. Additional research would be necessary toresolve these issues.lot T used printed versions of each puUlished case listed in the daCahase. It was neces-

sary to read the case, highlight the pertinent inf'orinatioi~, and then transfer it to thedatabase. I have retained for the file these marked-up versions that eontaineci data in-chided in the study.

200~~ ONE SI7F. TITS SOME 1311

unpublished cases. Many of the 152 entries in the database, however,involved the same SARE reorganization case due to multiple-reporteddecisions on the same property by the bankruptcy and appellatecourts. I deleted duplicate entries from the database, but augmentedindividual entries on particular SA.RE projects with data derived fromrelated reports.10z The resulCing National data see comprised forty-five usable cases. Because of the relatively srrxall number of observa-tions in the data set and the lack o£ randomness in the sample selec-tion, Ideveloped another database to test the robustness of myfindings.

While I was collecting my initial database on SA.RE cases, aunique opportunity to examine detailed court records came nny way.When Judge Lisa Hill Fenning decided to leave the bench in February2000, she gave me nine boxes of court documents she had collectedon her cases in the Bankruptcy Court for the Central District of Cali-fornia. Judge Fennin~g had compiled files on each business bank-ruptcy case over which she had presided from 1987 through 1995during her tenure on the bench. She collected case files on all kindso£ Chapter 1 i cases she had heard, not only on the handful for whichshe wrote published opinions.

A few words about her cases are in order. First, Chapter 11 caseassignment in the Bankruptcy Gourt for the Central District of Califor-nia is random; SAKE cases ~cvere only remotely assigned to a particularjudge. Thus, all judges presumably had an equal likelihood of hear-in.g aSARA case. Although it is one of Winery-four judicial districtsaround the country and its territories, through the mid-1990s the Cen-tral District of California was the largest in terms of number of Chap-ter 11 business bankruptcy cases filed.10~ From 1987 through ].995,

l02 None of Che cases inclixded in the database involved repeat filings ixi which thesame debtor or project was in Chapter 11 on more than one occasion. Some comments-tors view continuation of tk~e business or the lack of a repeat ding as an essential measureof success. See, e.g., Lynn M. LoPucki, Tlae Deblor in Full GonGrol—Systems Failure Under Gha~i-ter 1Y of the Bankru~itcy Code? (pt. 1), 57 AM. BANxiz. LJ. 99, 106-08 (1983) (defining thesurvival of a business as a measure of success). For purposes of this Article, however, Tmeasured the initial confirmation of a Chapter 11 plan without regard to repeat filings.This is the goal Congress has established for Chapter 11 cases. The Bankruptcy Code per-mits acourt to confirnn a Chapter II plan based on a reasonable likelihood, rather thancertainty or a strong probability, that conFirmauon will not precede liquidatiozl or furtherfinancial reorganization of the debtor. See 11 U.S.C. § 1129(a)(11) (2000).l03 See, e.g., THE 1993 BANICRUP'I'CX YrARBOOK BC ALMANAC 14-16 (Christopher M. Mc-

~-iugh ed., 3d ed. 1993) (showing that Chapter 11 business case filings in the BankruptcyCourt fnr the Central District of California constituted about 9% of all Chapter 11 businesscases filed nationally). Based on data compiled by the Administrative Office of the U.S.Courts, duzing 1987-1995, the Central District of California was the venue for 12,088Chapter 11 business bankruptcy cases, representing 8.18% of the 147,849 business bank-ruptcy Chapter 7.1 cases filed nationwide during those years. The next largest district wasthe Southern District of New York, which hosted 7,9:'71 or 5.05% of the business bank-ruptcy Chapter 1l. cases. See Ant~tN. S~RV. or -rr~~ U.S. CouRTS, 1995 JUDICIAL BUSINCSS OP

1312 COR.NELL LAW REVIEW [Vol. 87:1285

12,088 Chapter 11 business cases were filed in the Bankruptcy Court£or the Central District o£ California, coristituling over 8% of all busi-ness bankruptcy cases filed nationally.lo4 Although it is not possible tosay whether Judge Fenning's cases were a representative cross-sectiono£ cases filed across the country, her cases represent a sample of oneof the most active bankruptcy courts in the country. Furthermore,even though these cases reflect the administraeion of only one judgein only one district, they provided across-check against which i testedmy findings from my initial broader-based data. set.

I extracted evezy SAKE Chapter 11 case from Judge Fenning'sboxes. In some instances, the case file documents were inconnplete ormerely face-page filings with no supporting data; however, there were£ar more records of SAKE cases than appeared in reported opinions.Fortunately, many of the SAKE cases had detailed records. The docu-~rnents typically included bankruptcy petitions, schedules, and state-ments o£ financial affairs. If the case resulted in a confirmed plan, Ialso extracted data. from Chat document.

X extracted only those SAKE cases with suff cient information toidentify and research the matter further. Where the data were incoxn-plete, in order to expand the usefulness of these data., I reviewed eachcomplete case file and recorded additional information pertinent tothe study. X extracted the values in my L.A. database from the debtor'sbankruptcy petition, schedules, and statement of financial affairs, allof which were filed under penalty of perjury. If the debtor amendedthe schedules, I used the amended values. When there was an undis-puted azad a better source of information in the case file than the dataprovided in the schedules, I included that source in the L.A. database.Examples of better sources included undisputed appraisals of realproperty value, undisputed declarations of creditors detailing indebledness and arrearages, Internal Revenue Service statements of tax ar-rearages, and court findings.

TFIE UNITED STA'CES Coux-~s—J.995 REPORT or -rY-tE DzaECroR 268 tb1.F-2 (1995}; E~DMIN.SGRV. OP "I'HE U.S. COURTS, JUDICIAL BUSINESS OF TIi~ UNITED STATES COURTS, at AI-186Cb1.1'-2 ~1~9~~~ ~.DMIN. S~RV. Or THE U.S. COURTS, X~93~UDICIAL BUSINESS OP' THE UNITED

STATES COURTS—ANNUAL ~I'ORT OP THE DIRECTOIt~ at AI-~9O t~J~.F-2 (1993); f~.DMIN. S~RV.Or THE U.S. COURTS, 1~9`~ ANNUAL REPORT OF THE DIRECTOR—ACTTVFTII;S OF TI3~ ADMINIS-

TRATIVG OPI'ICE: JUDICIAL BUSINISS OP' THE UNITED STATL,S COUR~rs 316 tb1.F-2 (1992)) f~ll-MIN. SERV. OIL 'T'I-~H U.S. COURTS, 1991 L~NNUAI. REPORT OF THE DIRECTOR—ACTIVITIES OF'I't~1E

E~DMINISZ'RATIV~ ~FFICI.: JUDICIAL. BUSINESS Or TFIL UNl'C~D STAT~,S Coux~rs 296 tb],F'-2~1991~; ADMIN. S~RV. OI' T'HE U.S. COURTS, ANNUAL RIrPORT Or THE vIRECTOR Or TH~.f~DMIN-

ISTRATIVE OFFICE OF THC UNT'I'ED STATCS COURTS 240 tbt.F-2 (1990); f~iDMIN. SERV. OF THEU.S. COURTS, ANNUAL REPORT OF THE DIRECTOR Or TI-il: AllMIN1STRA'I'IVG OrPICC or TI-IC

UNITED STATES COCJRTS ̀3G`L tb1.F-`~ ~I9H9~; ADMIN. S~RV. OF THT U.S. COURTS, ANNUAL RE-

PORT OP THL DIRCCTOR Or '1'HG ADMTNTSTT2ATIV~ OrP'CC~ OP' TI-IT UNI'T'ED STATES COURTS 364

tbl.F-2 (1988); ADMTN. SGRV. OT'I'IIL U.S. COURT'S, ANNUAL ~LPORT OF TfIE DTREGTOR OF'~'I•IEADMTNISTRATT'VE OFFICE OF "I'I3E UNITED STATES COURT'S 3rJ1 C})1.F-2 ~IgBrI~.X04 See soua•ces cited su~ira note 103.

2002] ONE S17~ FITS SOMA; 1313

The L.A. database yielded eighty-three single asset bankruptcycases chat contained twenty Chree submitted plans of reorganization.Of the twenty-three submitted plans, the bankruptcy court confirmedthirteen of them. The two databases—one comprising i~aLional re-ported decisions and lawyer reports and a second comprising the LosAngeles cases—offer two approaches to understanding SAKE cases. Ialso combined the databases to co~aduet additional analysis, but fa-cused primarily on the National data set to avoid allegations that in-cluding the L.A. data set in the sarxiple would result in improperdistortion.lo5 Both the National and L.A. data sets include cases filedafter the effective date of the 1994 amendments: Although it is possi-ble that the 1994 amendrx~.ents caused a higher percentage o£ smallcases to £ail to confirm plans, T did not segregate the data to test thishypothesis. I chose to use the National data set to test zx~y hypothesesinitially and the L.A. and Combined data secs to test the robustness ofmy findings.

B. The Findings

The overriding question concerning SAKE cases is whether thegame is worth the candle; does the debtor's opportunity to reorganizebear fruit or does it sinn:ply impose cost and delay on the mortgageholder as some la~cv-and-economics theorists suggest? The answer tothis question necessarily sets the parameters for every other discussionabout the SARE process.

To answer this question, I analyzed the data to determine the fre-quency with which S.ARE debtors confirmed Chapter 11 plans.106 putof the Forty-five cases in the National database, seventeen debtors(38%a) confirmed plans. Some plans resulted in restructuring the se-cured debt while the debtor retained ownership of the property.Other plans resulted in the sale of the property. Still others were hy-brid plans; the debtor retained the property for a specified time whilecommitting to sell it or permit foreclosure if it did not repay the axiortgage holder's restructured debt within that time.

When Congress enacted Chapter 11, it noted that "[t]he purposeof [a] reorganization ...case is to formulate and have confirmed aplan o£ reorganization ...for the debtor."10'' Although confirmation

105 7~]~e author knows of no reason why Judge Fenning would treat SARA cases in LosAngeles any differently than would bankruptcy judges in other jixdicial districts.106 Previous studies have analyzed the success that real property debtors had in liqui-

dati~~g properties and concluded that only one in seven (about 14%) were successful, SeeLoPucki, su1ira note 102, at 109 & nn.47-49; see also Jerome R. Kerkman, The Debtor in FullControl: A Case forAdaption of the 'trustee System, 70 M,~Q. I.. Ri:v. 159, 167 (1987) (findingthat "zn Kansas City and Mil~cvaukee ... 74% and 76°l0, respectively, o£ the operating busi-nesses entering Chapter 11 proceedings were destined to fail" (footnotes omitted)).10'7 H.R. I2~r. No. 95-595, at 221 (1977), reprinded in 1978 U.S.C.C.A.N. 5963, 6184.

1314 CORIV~LL LAW REVIEW [Vol. 87:1285

o£ a SAKE plan is not a foolproof surrogate for positive social value,~Q8it is the recognized hallmark of a successful Chapter 11 case,109 even ifsome commentators regard it as underinclusivello or overinclusivell'

1os See, e.g., Douglas G. Baird, Bankruptcy's Uncontested Axioms, ~ OH YALE I.J. 573, 584(1998) ("Chapter I1 cannot be judged merely by counting the number of~firms that reor-ganize successfully.... [T]he rehabilitation goal must be balanced against other interests,including the need to recognize the rights of creditors.").l09 Sec, e.g., Samuel L. Bufford, Cha~iter 11 Case Management and Delay .Reduction: Ala

Empirical Study, 4 Ana, BANKR. INST. L. 12EV. 85, 103 (1996) ("The traditionally recognizedpurpose of filing a ckzapter 11 case is to reorganize the finances of the debtor by means of achapter 11 plan."}; id. at 103 n.82 ("By the traditional measure, the confirmation of achapter 11 plan constitutes success under chapter 11."); LoPucki & Whitford, su~rra note88, at 599 ("Bankruptcy lawyers and commentators sometimes consider a reorganizationcase to be successful i£ a plan of reorganization has been confirmed."); David P. Bart &Scott Pe1Cz, Rethinking the Concept of "Success" in Bankru~itey and Cm~iorate Recovery, AM. BANCCR.INST. J, (Am. Bankr. Tnst., Wash. D.C.), May 1998, at 1, 3'7 ("The emerging data suggests afar greater chance of ̀success,' as narrowly de£xned by chapter 11 confirmations, than wassuggested in previous studies."); Lisa Hill Fenning, Mediation, Not Litigation, AM. BANICR.INS~r. J. (Am. Bankr. Inst., Wash. D.C.), July/Aug. 1996, at 35, 36 ("Success in chapter 11 zs...typically defined as a confirmed consensual plan of reorganization."). Moreover, bothCongress and the Supreme Court have adopted triggers within Chapter 11 based on thereasonable likelihood that a court will confirm a Ghapter 11 plan within a reasonable time.See 11 U.S.C. § 362(d)(2)—(3) (2000); United Say. Assn v. Timbers of Inwood Forest As-socs., Ltd., 484 U.S. 365, 376 (1988).11O Judge Bufford is among these commentators. In his 1994 article, he writes:

There is a basic misconception about the success rate of Chapter 11 cases.. . [because of] a perversely narrow view o£ the nature of Chapter 11success.

Defining success in Chapter 11 requires much more analysis and de-bate than it has heretofox-e received. As a first approximation, I proposethat success Ue defined as the achievement of the results sought, or theavoidance of the results unwanted, by the debtor at the time of filing. Forexample, the debtor may want to sell the business, because the deUtor can-not make it profitable. After the filing, a sale is arranged and the case isdismissed. Alternative}y, the debtox maybe attempting to avoid foreclosureby the principal secured creditor on the principal real estate asset in thebankruptcy estate. The loan is restructured, ox a sale is arranged to a bet-ter-financed purchaser, and the case is dismissed,

Results of this kind are common in Chapter 11 cases, and frequentlyoccur in single-asset real estate cases, even though they do not comply withbankruptcy theory. However, such cases are all excluded from Che tally ofsuccessful Chapter X1 cases, according to the conventional countingmethod.

The real success rate for Chapter 11 cases is probably in the range of40%. This estimate is based on my experience with nearly 2000 Chapter 11cases that have been on my docket: no data have been collected nn thissubj ec~

Bufford, su1rr~ note 63, at 833-34 (footnotes omitted); see also Warren, su~na note 36, at 377(noting that a high proportion of Chapter 11 case liquidations does not indicate that thebankruptcy system is failing).1 z 1 Some commentators contend that "sixccess" should only apply to those cases in

which the debtor obtained confirnnation of a plan and continued in business. See, e.g.,LoPucki, su~»-a note 102, at 107 ("[T]he term ̀ success' will be applied only to proceedingsin which the debtor both obtained confirmation of a plan and was able to continue inbusiness ...."); LoPucki &Whitford, su~lrra note 88, at 600 ("Orie measure of this kind ofsuccess is whether the surviving entity xemained out o£ bankruptcy after conFirmation.").

2002] ONE S17~,~ FITS SOME 13X5

of all successful Chapter 11 cases. These connrnentators might con-Cend that my data counts many Failures as successes if the refiling rateis high £or the S.~RE debtors in my data sets.~1z Other commentatorsmight counter that the Banlrruptcy Code favors confirmation of a planand does not condemn refilings such that the refiling data are periph-eral to any study.113 This Article does not engage in ehe debate overdefining "success" in Chapter 11 bankruptcies. Instead, it nneasuresconfirmation of plans in Chapter 11, which is the benchmark adoptedby Congress.

Most Chapter 11 debtors file for relief under Chapter 11 with theobjective of confirming a Chapter 11 plan. A confirmed plan canrestructure secured and unsecured indebtedness, provide for sale orrehabilitation of the property, or permit the secured lender to fore-close. The outcome is usually consensual, reflecting the will of theparties to preserve value for each particular SAKE project. Occasion-ally, the paxties cannot agree on a consensual plan and the courtgrants the mortgage holder's request for relief fronn a stay,114 dis-misses the case, or converts it to a Chapter 7 case.115 Very rarely, thecourt confirms a "cramdown" plan over the dissent of the mortgageholder following a determination that the plan is "fair anal egLtita-ble."116 Fox the most part, the universe of SARE cases with confirmedChapter 11 plates will reflect a conservative measure of success.11''

Thus, these connmentators would exclude liquidating plans or plans that result in thedebtor refilix~g for bankruptcy From the category of successful Chapter 11 cases,112 See LoPucki 8c Kalisz, su~ri-a note $$, at 235 ("Refiling constitutes a failure of the

bankruptcy process.").r 13 See Robert K. Rasmussen &Randall S. Thomas, Whither the Race? A Comment on tTae

Effects of tlae Delazuarization of Cor[~arate Reorganizations, 54 Va,Nn. L. T2rv. 283, 293-95 (2001)(arguing that the Bankruptcy Code does not condemn refilings and that they are notcostl}~). See generally What Other Scholars Think of the LoPud~i/Kulin Study, BANKR. CT. D~CT-SIONS '~~KI,Y, NEWS BC COMM~NT~ Aug. 8, 2000, at A7 (reviewing academic reactions to thestudy) .114 See 11 U.S.C. § 362 (d)—{~ (2000).115 See id. § 1112 (b) .116 See xd. § 1129(b). See generally Kenneth N. Klee, fill You Ever Wanted to Knozu About

Crcana Doran Under tke Nezu Banlaru~tcy Code, 53 Atvt. BwNxx. LJ. X33 (19'79) (discussing theprocess by which courts confirm cramclown plans). Some might argue that a nonconsen-sual plan is unsuccessful because it diverts value From secured creditors. See s•u~rra note 50and accoix~panying text. It also is possiUle in some cases for' a creditor to propose a con-fix-mable Chapter 11 plan. See, e.g., In re Holley Garden Apartments, Ltd., 238 B.R. 488, 492(Bankr. M.D. Fla. 1999) (noting that both the debtor's and creditor's plans were confirma-Ule). Therefore in some respects confirmation of a SAIt~ plan could be overinclusive of"success."1 i7 .But see sources cited su~irca note 111 (contending that some commentators measure

cozl~rmation success Uy whether the debtor survives and does ~~ot refile for bankruptcy,and that even if confirmation is not diapositive of success, it is certainly relevant to assessingsuccess). Some commentators, however, adopt the view that state la~v Foreclosure, with allof its shorcco~nings, is preferable to any bankrupCCy reorganization, See, e.g., .su1ira notes47-50 and accompanying cexl.

1316 CORIVFI Y LAW I~VIEW [Vol. 87:1285

If SAKE cases were not likely to result in confirmed plans, thenCongress should have barred therm entirely from Che Chapter 11 sys-tem instead of allowing debtors i:o file subject to an expedited proce-dure. On the other hand, if there was a reasonable likelihood"g thatSAKE cases would produce confirmed plans, there would not appearto be any principled reasoi7 to subject them to rules different fromthose governing other kinds of Chapter 17 cases. The key is eo iden-tify those characteristics of SARE debtors that are good predictors ofconfirmed plans. Then Congress would have an informed basis onwhich to draw a line.

Based on ray practical experience with SA.RE cases, I had hypoth-esized that properties with larger property values and vaXue-to-loan ra-tios have a greater likelihood of confirmation.119 To test thesehypotheses, I examined the National data to determine whether cer-tain variables were indicative of increased likelihood of confirmation,including the property value, the property value natural log, the value-to-loan ratio (difference of natural logs)1~0 acid the like. The findingsregarding these variables were meanin~-ful with a Pseudo R.2 (Greene)of .28,121 but I needed additional analysis of all data to determine thevalidity of my hypotheses.

Analysis of the data reveals interesting patterns in SAKE cases.The National daCa reveal a strong relationship between property valueand confirmation of a Chapter 11 plan, a finding that the L.A. andComUined data echo. This means that a judge is more likely to con-firzn aplan in a case with a very valuable property than in. a case withlow valued property. In fact, the observed data are consistent with thisprediction. Of the seventeen cases in the National data set that re-sulted in confirnned plans, te~~ involved properties worth X8.2 millionor more.12~ On the other hand, only seven cases involved propertiesworth less than X8.2 million. Stated another way, o~ the eighteen casesin the upper 40th percentile of property value (valued at ~7 million ormore), ten (56%) resulted in confirmed plans. Of the twenty-sevencases in tl~e lower 60th percentile (valued at ~7 million or less), only

118 Reasonable minds can differ on the level of probability of confirmation that wouldsupport last-track r~,iles that disadvantage SARE debtors. Congress is well situated to en-gagc in this kind of line-drawing. Tigure ], infra, presents the kind of data that gives Con-gress an informed basis to do so.

j 1~ In my experience, properties with- larger values are also better maintained andmore currenC in payment of real property taxes than properties with smaller values. Ytested the data for these effecCs as well.

1 ~~ One can calculate avalue-CO-loan ratio Uy dividing the property value by the unpaidloan bal~u~ce. for example, a property worth ~.IO million subject to a ~p5 million loan bal-ance will have avalue-co-loan ratio of 2:1..121 See Wtc.t,in~t H. Git~E~E, ECONOMETRIC ANALYSIS 6~1 ~2C1 CCU. I~93~. T'OI' a ~ET1P.1'11

explanation of pseudo R' and other statistical measures, see infiu note 154.

1 ~2 See inf>-a Figure 2.

2002) o.1vE srzE FrTS soMZ;~ 1317

seven. (26%) resulted in confirmed plans.12~ At the extremes, the dataare even more striking: Chart 1 shows that of the nine cases in thelowest quintile, only on.e (11%) resulted in a confirmed plan, whereasof the nine cases in the highest quintile, six (67%} resulted in con-firmed plans. Thus, based on the raw data., it appears that somewherebetween ~7 million and $~8.2 million in property value there is a flex-ion point above which the likelihood of con#"irrr~ation increasessubstantially.

CHAl2T ~.

NATTOIVAI. DATA SET PERCENT CONk'TRM~D CI IAPTER 1 ~. PLANS BY

Q,UTNTIT.,~ BASED ON PROl'E:RTY VALUE IN MILLIONS OF DOLI.AI2S

0.7000

0.6000

0.5000

0.4000 ~-

0.3000

0.2000

0.1000 -

0,00000.41-1.8 1.9-4 4.3-7 7-12 13.3-130

Property Value (Millions of Dollars)

The L.A. data, shorn in Chart 2, involve more properties withlower property values. Of the sixteen cases in the lowest quintile, onlyone (6%) resulted in a confirmed plan, whereas six (38%) of the six-teen cases in the highest quintile resulted in a confirmed plan. Thesecond through fourth quintiles show no clear pattern with confirma-tion rates of 20%, 7%, and 13% respectively.

Dissecting the highest quintile of the L.A. data, however, reveals aflexion point similar to that reflected in the National data. Chart 3shows that o£ the seven cases with property values between :~5.8 nnil-lion and x$7.0 million, only one (14%) resulted in a confirmed plan,whereas five (56%) of the nine cases wieh property values of at leastX8.5 rr~illion resulted in confirmed plans. Thus the L.A. data also sup-port the inference thaC somewhere between $7 million aid X8.2 mil-lion in property value there is a flexion point above which thelikelihood of confirxxiation increases substantially.

The finding with respect to SARE Chapter 11 cases is consistentwith the understanding o£ Chapter 11 generally. Larger companiesare more likely to end their Chapter 11 cases with a successful reor-

1z~ See id. I have included properties valued at ~7 million in both the lower 60C1i per-

centile and in the upper 401h ~ercenCile.

13X8 CORX~JELL LAW REVIEW [Vol. 87:1285

CST 2L.A. DATA SST PERCENT GONFT12IvIED CHAP'T'ER 1I PLANS BX Q[JZNTTI..E

BASED ON PROPERTY VAI..U~ IN MILLIONS OF DOLLARS

0.4000

0.3500

0.3000

0.2500

0.20000.1500

0.1000

0.0500

0.0000

0.117-0.486 0.5-1.175 1.35-2.4 2.5-4.9 5.8-23.3

Property Value (Millions of Dollars)

ganization,124 This finding may reflect Che relatively high expenses ofa Chapter 11 reorganization. In effect, only larger cases can affordthe expenses of a reorganization in addition to the expenses of oper-atin.g the property. Smaller cases may be as complex as larger ones,125

but if they cannot afford to continue operations12~ and bear the ad-m.inistrative costs of the Chapter ].1 process,127 they may n.ot survive.

The National data also reflect a strong relationship between thevalue-to-loan ratio and the likelihood of confirmation of a Chapter 11plan, a finding on which the L.A. and Combined data are i».conclu-sive. The National data suggest, consistent with my experience andhypothesis, that cases with less leveraged capital structures are morelikely to confirm Chapter 11 plans. But the L.A. and Combined data'sinconclusive support for this proposition demonstrates the danger ofdrawing conclusions based on shared experience anct anecdotal testi-mony without adequate empirical research.

Examining raw historical data is only a beginning. This .Articlepresents a model that forecasts the likelihood of confirmation basedon historical relationships embedded in the data set. X selected prop-erty values and value-to-loan ratios as key independent variables

124 See Warren &Westbrook, sae~ira note $5, at 500 ("Because the complex structuralapparatus of Chapter 11 ... is based on a proCOrype of a business with sufficiently largeassets and debt to support an expensive restructuring, the businesses in Chapter 11 shouldbe relatively large."); see also LoPucki & Kalin, su1na note 88, at 255 (not.ing the extremelyhigh con~rnnation rate for large public companies from 1989 unCil 1997); LoPucki & Whit-foxd, su~»-a note 88, at 600 (reporting a 96% confirmation rate for large public companies).12r' See Gose Testimony, suer¢ noCe 78 ("I can sCate categorically that size does not bear

any relation to complexity. In fact, it is not unusual for a smaller transaction to be morecomplex than a larger; with less to fight over, more wrinkles may arise.").~ 2~' See I.oPucki, sicf»~a note 102, at ] 07 & n.32; see Kelso Kerkman, sacra note 106, at 167("[Between 74% and 76%] of the operating Uusinesses entering Chapter ll proceedingswere destined to fail . , ..").12'~ Chapter 11 administrative costs include attorney's fees, accountant's fees, ap-

praiser's fees, court fees, postpetition taxes, and the like. See I1 U.S.C. § 503 (b) (2000).

200~~ o~ sr~~ ~xrs son~z~ 1319

C~-~,.RT 3L.A. DA'I'A. SST PERCENT CONFTRM~7J CHAPTER 1 Y PLANS: GROUPINGS

SASI:D ON PROPERTY VALUE IN MTI,LIONS OI' DOLLARS

0.6000

0.5000

0.4000

0.3000

0.2000

0.1000

0.0000

0.117-0.486 0.5-1.175 7..35-2.4 2.5-4.9 5.8-7 8.5-23.3

Property Value (Millions of Aollars)

against which Y could predict the likelihood of a plan's confirmation.Because confirmation is a dichotomous variable—in that it either oc-curs ox does not occur—I assigned the value "1" to a case with a planthat was confirmed and "0" to a case where a plan was not confirmed.To understand more clearly the relationship between value-to-loan ra-tios, property values, and probability of confirmation, I first plottedvalue-to-loan ratios and property values against probability of conf"xr-nnation. No clear relationship emerged; it was not possible to find arx~.eaningful line around which the data would cluster. By using a lo-gistic regression,128 however, the relationships crystallized in a modelthat predicts the likelihood of confirmation.129 That is, given a partic-ular property value and value-to-loan ratio, the model illustrated inFigure 1 forecasts this likelihood of confirmation.'°

The National data model reflected in rigure 1 shows that bothproperty value and value-to-loan ratios are good predictors of confir-nnation.l~l For example, although the National rzaodel predicts thatcourts will confirm plans involving properties with a value of $$1 mil-lion and loans that are twice the property value (1:2) about 2% of thetime, it shows that courts are twenty times more likely to confirm ex-pensive (x$20 million) properties with the same loan ratio (40%).1~2

12~ Logistic regression is a statistical procedure that is useful for predicting dichoto-mous outcomes, in which the dependent variable can have only two possible values (typi-cally 0 or 1); the predictors can be either continuous or categorical. The relationshipbetween these variables is more clearly understood if we view the distribution of predictedconfirmations in a two-way table. See infra Appendix Table 1. It appears that both propertyvalue and value-to-loan ratios are food predictors of which cases courts will confirm, butthat property va117e may be more sensitive to ~eNhich cases courts will eventually confirm.12J Sre infrti figure 1; infra Appendix Table 1.13o rigure J., infra, suggests more precision i~~ the relationships loan a data set with

forty-five observations warrants. Nevertheless, it properly illustrates the direction of therelationships.t ~ 1 See infra Appendix TaUle 2.132 See su~1n-a Figure 1; infra Appendix Tabie 1.

1320 CORNELL Lf1W RL'VIEW [Vol. 87:1285

Ficu~i;: 1NATIONAL MODEL: PR~bTCT~D RATE OF CONTII2IvLATTON BY

PROPERTY VAI..UE AND VALUE:=TO-LOAN RATIO

100%

0 90%.~

~ 80%

70 ~o~j 60%w0 50%

40%

~ 30%

;~ 20%

a 10%

0%

1:3 1:2 1:1.5 1:1 1.5:1 2:1

Value-to-Loan Ratio

~' $20 million ~ X7.4 million ■ $2.7 million ~ $1 million

Those with both a high value and a high value-to-loan ratio are almostcertainly confirmed (95%).1~~ The National model indicates thatboth the property value and value-to-loan ratio axe good predicCors ofconfirmation.

The L.A. and Combined data provide strong support for the rela-taonship generated from the National data between property valueand probability o£ plan confirmation.l~~ But the L.A. and Combineddata are inconclusive regarding the relationship between. the value-to-loan ratio and the probability of plan confirmation.l35 The L.A. andCombined data suggest that property value may be more sensitivethan the value-to-loan ratio in predicting confirmation.'~~ As a result,I focused on the property value data alone as a predictor ofconfirmation.

The National model and data strongly suggest that property valueis predictive of confirmation in SAKE Chapter 11 cases. Thus, prop-erty value is a particularly good predictor of the probability that acourt will confirm a Chapter 11 plan in a SARE case.137 Figure 2 dena-

1~~ See su1ira Figure 1; infra Appendix Table 1.134 See infra Appendix Table 2.

13r~ See id.136 See id.

1 ~~ The Wald statistics aa~e set forth in Appendix Table 2, infra. For a more thorough

d►scussion of the statistical methods, see infra Appendix A.

2002] ONE SIZE SITS SUMS 1321

100%

80%

0.~ro

60%

0

~' ~~ /0

.afd

Os.a

20%

0%

FIGURE ̀~

NATIONAL MOIJI:I.,: PROBABILITY OF SARF. PLAN

CONFIRMATION BY VAI,U~ OF PROPERTI'

~o

♦ ~

s+++

~♦ •

'~'

-~-

-I-

+ +++ ~ +

-~'+ ~'+ '~'

,~

~ Confirmed

10 100

Value of Property (,°~ Millions)

-}- Not Confirmed

0V

r~

onstxates the fit for the National data using a logarithxzaic axis foz

property value and symbols to indicate confirmation.

These data may also be tabulated as in Chart 4:

Cz-~T 4NATIONAL MODEL: PREDICTED PROBABILITY' UT' CONIIT2TvIATION

BASED ON PI20PLR'I'X VAT.UL

Property Value(~ Millions) 1 3 5 10 15 20 30 50

Probability ofCor~£~rmation 9% 23/0 32% 46% 55°Jo 61% 69% 78%

These data justify raising the SARE cap to a property val~Ye of about

$10 million. At that level, confirmation is almost a~1 even bet. At the

X20 million Jevel, the likelihood of confirmation is about 60%.

Figure 3 reflects the relatio~~ship between property value a~ad

probability of confirmation without using a logarithmic scale or in-

cluding symbolic representation of confirmation.

These figures illustrating the National nnodel support my hypoth-

esis that SA.RE cases with larger properties have a good chance of hav-

1322 CORNELL LA.W REVIEW [Vol. 87:1285

FicuRr, 3NATIONAL MODAL: PROBABILITY OF PLAN CONFIRMATION

BY PROPERTY V,4I.U~

90%

80%a•~ 70%~a

60%G~j 50%wO 400~~

30%

0 20%a

Z 0%

0%

O

L

0 10 20 30 ~i0 50 60

Property Value (~$ Millions)

ing a Chapter 11 plan confirmed.138 More importantly, they clearlyshow that a "one-size" Chapter 11 process does not fit all SARE cases,at least where the one-size procedure does not afford all debtors areasonable opportunity to reorganize,139

Not having made a similar investigation, Congress engaged in itsprocess unaware of such information. Congress listened to the lend-ers who lobbied for the bill and the House and Senate each passedbills blowing up the ~4 xxxitllion cap. The resulting decision reflectedin the 2001 Amendment was a shot in the dark that missed the mark.

LESSONS FROM APPLXING THE DATA TO THE

`ZOOS AMENllMENT

As a policy matter, Gongs ess blundered when it proposed to re-peal the ~~ million cap in. the definition of SAKE debtors. The 2001AmendmenC would expose larger SARA debtors to the strictures of thenewly expanded ~ 362 (d) (3) of the Bankruptcy Code. To survive theChapter 11 process, they would have to file a confirxn.able Ghapt~r 1 J.plan within ninety days of the order £or relief, persuade the court toextend that tune, or start making payments to their mortgage holders

13a The L.A. aid Combined data generally reinforce this hypothesis.icy Before 1994, under the Bankruptcy Code, one size fit all SARA cases precisely be-

cause the o~~e size was Che general, flexible reorganization z~ule applicable to almost X11Chapter 11 debCors.

2002] ONE SIZE FITS SOME ].323

based on nondefault interest under the coiitract.140 This recipewould give secLrred mortgage holders effective co~ztrol of the SARAChapter 1 L case. These lenders will have obtained what they paid forto the detriment of the property owners, the unsecured creditors, andthe general public. Congress should have proposed a less restrictivealternative that would have better served and harmonized the com.pet-ing interests in SAKE Chapter 11 cases.

Congress could have adopted the posiraon of law and-economicscritics that Chapter 11 is inefficient and should be replaced by an auc-tion system141 or abolished altogether.142 But Congress has elected toretain the Chapter 11 system for xr~ost debtors, including SA12E debt-ors. By most accounts, the mark of success under the Chapter 11 sys-tem is, at the very least, con£~rmation of a Chapter ].1 plan,143 Thus,

14o See Bankruptcy Re~'oz•m Act of 2001, H.R. 333, 107th Cong. ~ 444, available at http://thomas.loc.gov; Bankruptcy Reform Act of 2001, S. 420, 107th Long. § 444, available athttp:// thomas.loc.gov.14t See Baircl &Morrison, sufira note 48, at 369, 371. Baird and Morrison advocate for

such a system:In a mandatory auction regime, managers of firms that have value as goingconcerns will do everything they can to make this information readily avail-able at the start of the case. They will keep their jobs only if a single buyerof the assets can be found, and the chances of finding such a buyer go upthe snore such iz~£ormation is available... .

... Only a system of mandatory auctions both limits the amount ofrime an inexpert decision maker handles the shutdown option and forcesinsiders co give Chat. decision maker sufficient information to exercise theoption. well while it is iii. leer hands.

Id.; see also Douglas G. Baircl, 1'he Uneasy Case for Corj~orate Rearg~unizt~taons, I5 J. LT,GAL STUD.

127, 145 (1986) (criticizing bankruptcy law as not reflective of market preferences); LucianArye Bebchuk, A Nezu flp1»nacla to Cor~arccte Rco~gunizcctions, X01 Hway. L. Rev. 77!5, 778-81(1988) (noting same).14Z See, e.g., Michae] Bradley &Michael Rosenzweig, Tlae Untenable Case for Chu~Cer 11,

101 YA~.L L.J. 1043, 1078 (7992) ("C7aa~ter 11 s/tould be repealed, abolishing court-su1ieruiseclcar~o~ute reorganizations ancl, i7a effect,1irecluding resiclual claimants from 1~artiri~~zting in any reorganization of tl~e firm.. , . [W]e propose a federal law repealing Chapter ll ... anti provid-ing for automatic cancellation of residual claims in the event of default." (emphasis inoriginal)) ,~~~ See sources cited su1ira mote 109. I3~~t see, e.g:, Douglas G, Baird, Bccnhru1itry's Uncon-

tested Axioms, 108 Ya[.~ T.J. 573, 5$4 (1998) ("Chapter 11 cannot be judged merely bycounting the number of fzxxns that reorganize successfully.... [T]he rehabilitation goalmust be balanced against ocher interests, including the need to recogizize the rights of

creditors."); Bufford, sze~irte note 63, at 833. Judge Bufford writes:

As a first approximation, I propose that success be defzned as the achieve-ment of the resulCS sought, oz~ the avoidance of the results unwanted, by thedebtor at the time of filing. For example, the debtor may want to sell thebusiness, because the debtor cannot make it profitable. After the filing, asale is arranged ar~d the case is dismissed... .

...However, such cases are all excluded from the tally of successfulChapter 11 cases, according to the conventional cotmling method.

Id.; Steve~~z H. Ancel &Bruce A. Nlarkell, Ho~~e in the Heartland: C,ha~ter 11 Dis?positions inIndicants and Saxitherre .11li~aois, 1990-1996, 50 S.C. L. T2~v. 343, 357 (1999) ("Tize conse-quences oatlined above hint at a definition of success ...that is Uroadex than simply

7324 COI~NILI I,AW I~V7EW [Vol. 87:1285

the question addressed in this Article is not whether the law shouldpermit SAKE debtors to reorganize undea Chapter 11, but under whatconditions SAKE debtors may reorganize.

In X994, Congress established a separate procedure for smallSA.R.E debtors with secured debts not exceeding ~4 million. Sincethen, nothing has happened to ~varrant applying the separate SAREprocedure to larger cases. Tn fact, instead of conducting diligent legis-lative factfinding as it had done on other occasions, Congress gath-ered no erx~pirical data to analyze larger SAKE cases. Instead, it choseto receive anecdotal testimony144 and money frorr~ mortgage holders'lobbyists.14' A.s this Article demonstrates, the data. strongly supportthe proposition that larger S11~ZE cases have a high likelihood of con-fzrming Chapter ].3. plans. The same may be true of cases with highvalue-to-loan ratios. Repealing the ~$4 million cap so as to subject allSARA debtoz-s to the requireme~~.ts of ~ 362 (d) (3) of the BankruptcyCode probably will reduce the likelihood of confirmation for severallarge SAKE debtors. By some standards, this will diminish the successof Chapter 11, thereby adding fuel to the fire of the commentatorswho call for Chapter 11's repeal.

By drawing a reasonable line to differentiate small SAKE debtorsfrom large SAKE debtors, Congress could have preserved the eco-nonnic braking function of Chapter 11 in preventing unco~atrolleddownward spit als in. real estate prices when mortgage holders simulta-neously dump numerous foreclosed properties on the market,l46 It isizxiportant to recall that this systezx~ benefits society by guarding theeconomic health of institutions that finance real property, in additionCo t~1e financial well-being of the property owners.147 In fact, insteadof drawing a line based on the amount of secured debt, Congressmight have done better to consider property value and the value-to-loan ratio instead. As Appendix Table 7 illustrates, even SARA caseswith ~1 million in property value have a 39% chance of confirmationwhen the value-to-loan ratio is 2:1.i4~ Quite clearly, the data support amope textured look at these cases. Indeed, the data raise the question

confirming; a ChapCer 11 plan.... [T]he authors believe a rough definition of a successfulChapter 11 is one in which all participants receive more than they would have if liquida-tion had been initiated.").1n4 See sources cited s2e~ira notes 78, 80.

1 q' ~ See .Bunkru~idcy, su~n-a note 15.146 If dumping small SARA properties on the market causes a downward spiral, then

drawing a line to insulate large SARA debtors from the restrictions of § 362 (d) (3) will notsuffice. To prevent the spiral, Congress would need to repeal § 362(d) (3).

t`~7 See sup~r~a notes 67-68, 71 and accompanying text.14 3 Sen, infix Appendix Table 1. Although the National data support using value-to-loan

ratios as indicative of the proUability of confirming a SAItE plan, the L.A. and Combineddata are inconclusive on this point. See infra Appendix Table 2.

2002] ONE SIZE FITS SOME 1325

whether the law should use debt levels alone as an eligibility limitationfor any purpose under the Bankruptcy Code.

Moreover, the case in favor of drawing a reasonable line is com-pelling. As noted above, the National model uses confirmation of aChapter 11 plan as a surrogate for success.14J However, many com-mentators acknowledge that confirmation is only part of the measureof success.''0 Soine SAKE Chapter X X cases that resulted in dismissalswere undoubtedly the p~ oduct of negotiated settlements. I£ the 2001Arnendrnent is enacted into law, however, as it becomes more difficultto confirm plans, there will be less reason for a mortgage lender tonegotiate a reasonable settlement. Hence, with this change in the law,both the visible and the invisible successes in SAKE Chapter 11 caseswill be less likely to occur.

CONCLUSION

The data strongly support the application of the more relaxedcurrent Chapter 11 procedures in larger SAKE cases where theprobability of confirmation is high. There is no rational justification£ox stu~£zng valuable properties with. high values (or possibly highvalue-to-loan ratios)1~1 into an expedited SARE procedure that will al-most surely decrease the confirmation rate.' Sz policynnakers reasona-bly can disagree about whether they should draw a line at a propertyvalue of ~5 million, where the probability of confirmation is 32%, $XOmillion, where the probability of confirmation clzxnbs to 46%, or $15

14~ See su~rra note 109.1 ~'~ See LoPucki & Kalin, s2cpru note 88, at 235.151 Based on the lack of staCistical sigz~i~cance in the L,A, and Combined data sets, I

would require more data to determine definitively the relationship between value-to-loanratios and the likelihood of confirmation.1~2 I did not elicit comprehensive data regarding the length of time it took debtors to

confix•m Chapter 11 plans in large SARE cases. Based on my experience, however, mostlarge SAKE cases require more than ninety days to confirm a plan o£ reorganization. Someof these cases (lave operating problems that parties in interest must fix before they reasona-bly can pz-edict the earning potential of the reorganised debtor and use it to negotiate aplan. Otl~ex~ cases involve debtors with complex capital structures, tax issues, foreign Iend-ers, and the like, which delay the plan negotiation and confirmation process. If the 2001Amerzdmene becomes law, some SA12E debtors will fail to reorganize as a result of exposureto the expedited procedures. Others will reox-ganize on a different basis than they wouldhave before the adoption of the 2001 Amendment as a result of value being shifted fromowners and unsecured creditors to secured lenders. A few large SARL, debtors inay reor-ganize in a more expeditious fashion than they would have before the adoption of the2001 Amendment. Ii~.deed, based on their previous writings, some commentators mightargue that expedition would lead to higher coz-~fzrnnation rates and no lower rate of busi-ness survival. See, e.~., LoPucki, su~ira note J 02, at 100–01 (noting that under Chapter XI ofthe Bankruptcy Act, sl~o~-ter proceedings probably x-esulted in a higher con~x•~nation racethan under Chapter 11 of the Bankruptcy Code and no lower rate of business survival);Lynn M. LoPucki, '1'lie De6tm• in Full Control—Systems Failure Under Cha1~ter I1 of the Bankru~~tcyCode? (pt. 2), 57 Ate. Bn~xR. LJ. 247, 269-71 (1983). One would need to conduct addi-tional empirical research to quantify the results.

1326 COI~NELL LAW .REVIEW [Vol. 87:1285

million, where the probability of confirmation is even better, aC 55%.But it is plain that any line should be drawn based on consideration ofactual data, not on a shortcut rule that treats all SAKE debtors lessfavorably than other Chapter Y 1 debtors. Tf a X50 million property hasa 78% chance of confirming a plan under existing law, what policypossibly justifies jamming it into an expedited procedure that mightjeopardize this result?153 Whether Congress should draw that line at$4 million in. secured debt, or at ~7.~k million, $20 million, ox somedifferent amount of property value, is an issue about which reasonablepeople can 'disagree, but it is clear that a line should be drawn.

Congress used a meat axe when it should have used a scalpel.Perhaps before Congress completes its deliberations on bankruptcyreform legislation, it will reinstitute a reasonable SAKE cap. This Arti-cle and similar studies should serve to sharpen the debate.

~'~ Commentato~~s disagree whether expedition of the Chapter ll process will reducethe plan confirmation rate. See supra note 152.

2002] ONE SIZE FITS SOME 1327

AYPr:.Nprx A: ST'ATIST'ICAL, Mr,•rxoi~s

As noted above, logistic regression is a statistical procedure that is`useful for predicCing dichotomous outcomes, in which the dependentvariable can have only two possible values (typically 0 or J ); thepredictors can be either continuous or categorical. In this study, thedependent variable is whether the court confirnned the plan. It iscoded "1" if there was confirmation, and "0" if there was no confirma-tion. Both of the independent variables (Value of Property and Va1ue-to-Loan ratio) are continuous.

The logistic regression coeft`icients reported in Appendix Tabie 2are exponents, the natural logs of the odds ratio (ln(p/1—p)). Unlikeordinary least squares coefficients, one cannot interpret logistic coeffi-cients independently of the model within which they are nested.154

That is, the entire model is a function that one must calculate in orderto determine the effect of an individual independent variable. Forthis purpose, we can restate the regression as follows:

Log Odds of Confirmation = —2.10 + (Value of Property x 1.11) +(Value-to-Loan ratio x 2.37) .

~"4 G. David Garson describes R2 and pseudo I22 statistics as follows;• R-squared. There is no widely-accepted direct analog to OLS regression'sR2. This is because an R2 measure seeks to make a statement about the"percent of variance explained," buc the variance of a dichotomous or cate-gorical dependent variaUle depends on the frequency distribution of thatvariable. For a dichotomous dependent variable, for instance, variance is ata maximum Fora 50-50 split and the more lopsided the split, the lower thevariance. This means that IZ-squared measures £or logistic regressions wzthdiffering marginal distributions of their respective dependea~t variables can-not be compared dzrectly, and cox~nparison of logistic R-squaxed measureswith Rz from OLS regression zs also problematic, Nonetheless, a nu~x~ber oflogistic R-syixared measures have been proposed. Note that R~-like mea-sures below axe not goodness-of-fit tests buC rather attempt to measuresrength [sic] of association. For small samples, for instance, an R2-like mea-sure might be high when goodness of fit was unacceptable by model chi-square or some ocher test.

[•] Cox and Snell's R-Square is an attempt to imitate the interpretation ofmultiple R Square based on the likelilioocl, Uut its maximum can be (andusually is) less tl~.an 1.0, making it di£~cult to interpret. It is part o£ SPSSoutput.[•] Nagelkerke's R Square is a further modificaCion of the Cox and Sne11coefficient to assure that it can vary from 0 to 1. That is, Nagelkerke's R2divides Cox and Snell's R2 by its maximum in order to achieve a measurethat ranges from 0 to 1. Tl~crefore Nagelkerke's R-Square will normally behigher than the Cox and S~~ell measure. It is part of SPSS output.

[•] Pseudo-T2-square is a [sic] Aldrich and Nelson's coefficient which servesas an analog to the squared contingency coefficient, with az1 interpretationlike R-square. Tts maximum is less than 1. Tt may be used in either dichoto-mous ox multinomial logistic regression.

SC2 G. DAVID GARSON, Logistic Regression, 212 PA ~I6J S'fr\TNO'PLS: AN ONLINE TEXTBOOK, uthttp://w~v~v2.chass.~~zcsu.edu/garsoz~z/pa765/logistic.htm (last visited Maz•. 22, 2002) (cita-tion omitted).

1328 CORNLLL LAW REVIEW [Vol. 87:1285

In order to reco~crer the proUability o£ confirmation for a given prop-erty or type of property, one would add the values into the equationabove, raise Euler's constant (e) to the resulting value, and then calcu-late the odds.

For example, assume that the property is fully mortgaged; Chevalue-to-loan ratio (which is the difference between the legged values)is equal to 0. This allows us to see what happens as the value of prop-erty varies. The value-of-property variable comprises the lodged valuesof the properties, in millions of dollars, so that a value o£ 1 in thevariable is equal to $$2.72 million in the real world; a value of 2 is equalto $'7,39 xxzillion, and so on. If we use the National data set and select1 as the value of property, we would get the following equation:

Log Odds of Confirmation = —2.10 + 1 x X.11 = —0.99

Odds = E`0~`'~ _ .37:1.

Once we compute the odds, we generate probability by dividing theodds by one plus the odds:

Probability of confirmation = .37 / 1.37 = .27 or 27%.Now let us assume a property with the same value-to-loan ratio of 0,but a value of property variable value of 2 (an actual property value ofX7.39 million). We would state the equation for the National data setas follows:

Log Odds of Confirx~nation = —2.10 + 2 x 1.11 = .12

Odds = E`2 = 1.13:1

Probability of Confirmation = 1.J 3 /x.13 = ,53 or 53%.

We understand more clearly the relationship between these prop-erty value and value-to-loan ratio variables if we view the distributionof predicted confirmations in a ttiva-way table (Appendix Table 1).The numbers illustrate how both the property value and the value-to-loan ratio appear to be important factors underlying the confirmationdecisions of bankruptcy courts. The model predicts confirmationabout 2% of the time of plans involving properties with a val~~e o£ ~1million and loans that are twice the property value (1:2); and predicts

confirmation of plans :for expensive ($20 millio~~.) properties with thesame debt ratio as twenty times more lilzely (40%). Confirnnation ofplans involving properties with both a high value and a high value-to-loan ratio is almost certain (95%). Therefore it appears thaC bothvalue and loan ratios are good predictors of confirmation failure, butthat val~.Ye may be more sensitive for pz edictizzg co~~firmation.

Tv understand the relationship between the property value, the

value-to-loan ratio, and the probability of confirmation :from a differ-

ent perspective, consider Figure 1 above. This figure clearly shows a

sL~bstantial likelihood of confirmation when the property value is at

least $7.4 million and the value-to-loan ratio exceeds 1:1.5. In fact,

2002] ONE SIZE FITS SOMF. 132g

A~f'PENDIX TAF3I,E I

NATIONAI. MODEL: PRF,DIC`I'ED RATE OT' CONFIRMATION ICY PROP~I.TY

VALUE AN17 Vt1LU~-TO-LOAN RATIO

Ratio of Property Value-to-Loan P~~incipal

l'roperry Value 1:2 1:1.5 1:1 1.5:1 2:1

~J million 2% 4Io 11% 24% 39I

~2.7 million '7% 12% 27Io 50% 66%

$~7.4 million 18%a 30% 53% 75°Io 85%

~¢20 million 40% 56% 77% 90% 95%

Note: Entries are ehe percentage o£ cases within. tl~e cell that are predicted to be confirmed.

using that value-to-loan ratio, if the property value exceeds x$20 mil-lion, confirmation is more probable than not.

AI'P~NDIX TA13I.,L 2FACTORS OF Bt1NKItUPTG'Y PI.,A.N CONFIRMATION IN SARE CASES

Data Sow-ce

National L.A. Combined

Property Valued 1.7.1 ̀ 'F .52'~` ,73'x'

(8.53) (3.55) (13.60}

(mea~z 1.72, srl 1.26) (mean .SY, sd 1.20) (mecen .95, srl 1,35)

Value-eo-Loan Ratio- 2.37* —.68 —.09

(5.28) (1.84) (.08}

{mean —.27, scl .51) (mean .31, scl .77) (mean .10, scd .74)

Constant —2,10 ~" —1.82`* —2.02~`Y(7.40) (19.58) (29.46)

Pseudo-R2 .42 .13 .20

N 45 76 121

k~i<.05,'~~~~<.O1~- Property value is the natural log of the assessed value in miliioris of dollars. Value-to-loan ratio

is the difference in the natural logs of the property value and Che oucs[anciing loan amount in

millions of dollars.Note: Gell entries are logistic regression coefficients. Wald statistics are in parentheses.

As noted above, the National data predict the probability of con-

firmation bath as a £unction o£ property value and value-to-loan ratio.

By contrast, as illustrated by Appendix Table 2, the L.A. and Con~-

bined data support the relationship only fox property value, but not

fnr value-to-loan ratio. The L.A. data thus make the National data on

property value more robust des~aite the lack o£ a random sample and a

small number of cases, but undermine the National data's iax~plica-

tiozls for value-to-loan ratio. Appendix Table 2 also uses Wald statis-

tics~" to show the tighter fit for property value data versus value-to-

loa~z data. Note that Appendix Table 2 uses Wald statistics instead of

15~ Id. ("Computationally, the Wald statistic = b`' /ASE,,' where ASE,,' is the asymptotic

variance of Che logistic regression coefficient."). Garson further explains the'~1ra1d statistic:

1330 CORNET L LAW I~VIEW [Vol. 87:1285

standard errors, but Wald statistics derive from standard errors andtake into account the number of cases, making them as good or betterthan standard errors fox measuring goodz~.ess o£ fit.

Figures 2 and 3, above, demonstrate the effect of isolating theanalysis of the National data set to Focus on proUability of confirma-tion based oar property value alone.

The Wald statistic is eoininonly used to test the significance of individuallogistic regression coefficients for each independent variable (that is, to restthe null hypothesis in logistic regression that a particular logat (effect) coef-ficient is zero). It is the ratio of the unstandardu•.ed logit coefficient to itsstandard error. Tlie Wald statistic is part of SPSS output in the section"Variables in the EquaCion." O£ course, one looks at the correspondingsignificance level rather than the Wald statistic itself . , .

. t11so note that the Wald statistic is se~~sitive to violations of thelarge-sample assumption of logistic regression.

Id.

~oo~~ o~ srr~ rrTS sow 1331

APPENDIX B: SINGLE ASSET RL:AI,. ES~'f1'I'~ {SA.RE~ QUESTIONNt-1TRE

Please duplicate this Questionnaire and fill out a copy for each singleasset real estate deal you have dons since October 1, 1979. Please

return the completed questionnaires to Professor Ken Klee, UCLA

Law School, P.O. Box 95J.4'76, Los Angeles, CA 90095-1476 as soon aspossible but in no event later than March 13, 1998.

1. Type of Property (Apartment Building, Raw Land, etc.)

2. Valuation Range o£ Property

3. Type o£ Settlement: Out o£ Court ; Crazx~down ; Consen-sual Plan

4. Were maintenance and taxes current pre-workout or prepetition?

~~'/N)5. Terms of Debt/Settlement:

A. Senior Secured Creditor with Mortgage or Deed of Trust onReal estate

Priority of Lien: (Sho~.ild be First; Indicate if any subordination} _

Amount of debt? (Pre and Post Workout or Plan)

Interest Rate? (Pre and Post Workout or Plan)

Term? (Pre and Post Workout or Plan)

Other Relevant Information

B. Junior Secured Creditor with Mortgage or Deed of Trust onReal Estate

Priority

Amount of debt? (Pre and Post Workout ox Plan)

Interest Rate? (Pre and Post Workout or Plan)

Term? (Pre and Post Workout or Plan)

1332 COPNELL LAW REVIEW [Vol. 87:1285

Other Relevant Information

C. Other Secured CreditorPriorityAmount of debt? (Pre and Post Workout or Plan)

Interest Rate? (Pre and Post Workout or Plan)

Term? {Pre and Post Workout or Plan)

Other Relevant Information

Debtor (identify the Debtor i£ the information is Not Confidential)

New or Retained EquityNew Capital InfusedManagement Contracts, Salaries, or Other Private Benefits

Debt ForgivenRelevant Information