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ABI Commission to Study the Reform of Chapter 11

June 4, 2013 Field Hearing

New York Institute of Credit

New York, NY

Bob Keach:Good afternoon, we’re going to go ahead and get started. Welcome. As co-chairs of the ABI Commission to Study the Reform of Chapter 11, Al and I want to thank the New York Institute of Credit for hosting this hearing today. Initially, we'll hear from a number of witnesses today on certain critical, and at times controversial, topics.

One, the Bankruptcy Code’s treatment of leases of non-residential real property, including the effect of the provisions of BAPCPA limiting the time period for assuming or rejecting such leases on reorganizations. Two, the Bankruptcy Code’s treatment of licenses of intellectual property including patent, copyright and trademark licenses, of which a debtor is a licensor or licensee. In addition, we'll also hear from a witness regarding problems facing middle market and small business debtors, which is a topic we probably can't visit often enough.

Al and I would like to begin with some brief remarks about the Commission and both hearings that have been held and upcoming hearings. Then, I’ll briefly introduce the topic and we'll get started with the introduction of the witnesses and testimony.

Al?

Al Togut:First off, everyone, thank you for coming. I think you're going to find today the next hour and a half time well spent and extremely interesting. I just want to talk a little bit about this process, the field hearing process.

We have posted on the Commission website, a complete opening statement which you can read. We have on there our mission statement. We have a listing of all the Commissioners. We have a listing of all the topic areas that we are studying. We have 130 people populating committees that are looking at various aspects of bankruptcy reform. This piece, which is the field hearing component, is a very important part of what the commission is doing where we had hearings around the country last year and we're continuing this year.

Last year we had public field hearings in Washington, New York, San Diego, Boston, Phoenix and Tucson. Bob Keach and I went out to Arizona twice in three weeks to Phoenix and Tucson and we heard testimony from more than 20 witnesses covering a variety of topics. [*] We have eight more hearings around the country and what we're trying to do is have hearings in each judicial circuit in the U.S.

The testimony we have received has been very helpful to us. We are also accepting written submissions. This is important for the people who cannot get to the table to testify. We are accepting written submissions on any topic. They will be reviewed and considered by the Commission. * This year, we will be in Chicago, Atlanta, Austin, Texas and a variety of other places.

We are very grateful to our panel. We have two panels today. [*] The BAPCPA provisions provided for a maximum time period for the assumption or rejection of commercial leases. It's been controversial since its initial passage. Some have blamed the provision for the demise of both the designation rights market and retail reorganizations, with those two events being perhaps connected.

Others contend that the provisions [of BAPCPA] brought the need for certainty for landlords, preventing a contagion of failures within shopping centers and that the perceived decline in the retail restructurings is the product of externalities rather than any statutory change.

Years of practice under the Bankruptcy Code have exposed other ambiguities affecting commercial leases with courts split over the issue of so called “stub rent” and issues of the standard for measuring adequate assurance of future performance when a lease is assumed and assigned. We will examine those topics and more today.

No category of contracts has generated more controversy than licenses of intellectual property, including licenses of patents, copyrights and trademarks. The circuits have been split for years over whether a debtor in possession may assume such contracts, even when it will not attempt to assign the contract, leading to forum shopping around this issue. Recent decisions have also created a circuit split over the effect of a debtor licensor's rejection of a license on the rights of non-debtor licensees, both in areas covered by Section 363(n) and not expressly covered by that provision. A number of other ambiguities and issues abound in this crucial area for modern reorganizations that often center on such intangible assets. We will hear from witnesses on these critical and complex issues. Concern has been raised in prior hearings on the increasing costs of reorganizations and the impact of such costs on the continuing viability of Chapter 11 for small and middle market companies. We will also briefly revisit that topic today.

With that, by way of introduction, we turn to our first panel of witnesses. We will hear from all of the witnesses on the panel first and then ask the witnesses to take questions from the Commission before moving to the next panel.

I also need to mention that we are pressed for time. The speakers have the red, yellow green lights on the box. [*] Green, you're good for five minutes. Yellow, start wrapping it up and red, your time is up so that light goes on, and you have to quit.

Keach:

We will come back to you with the questions so you'll have lots of chances to contribute.

Togut:

You'll have plenty of time. You can do like the politicians do. When we ask the question, you answer whatever you want. Okay, so the first panel consists of Lawrence Gottlieb of Cooley L.L.P., Elizabeth Holland of Abbell Credit Corporation and David Pollack of Ballard Spahr. Have you decided among you who would like to lead off?

David Pollack: We'll start with Larry.

Togut:

Okay, we'll start with Larry. You don't have to read your statement. We've got them and we’ve read them, so you can feel free to summarize.

Lawrence Gottlieb: My name is Larry Gottlieb and I've been practicing in the field since when the Bankruptcy Act still existed, so I don't know if I'm unique, but I'm there. I've been handling retail cases. I think most of you would agree I've had more than my share of retail cases over the last three decades. I want to talk about [Section] 365(d)(4). In my view, that is the worst provision of all the bad provisions of the 2005 [BAPCPA] amendments.

Why is that? Well, first because of the 210 day limit and the little time that you have to market leases, assuming that you can't be assured that they’ll be assumed past the 210 days. As the value of leases has decreased markedly, there are no more meaningful designation rights and as a result, creditors do significantly worse in retail Chapter 11s than they did before.

In several instances, in the old days, that is prior to 2005, designation rights enabled unsecured creditors, who otherwise were being treated poorly to say the least in these cases, to have a fund to litigate if necessary. Certainly in a case that we handled, Montgomery Ward, the debtor believed that there were no funds for unsecured creditors and they could do whatever they want. As a result of designation rights, they were able to litigate against GE which otherwise would have been impossible. But most important, no retailers in my view, as best I can tell from my research, [*] have reorganized except for very few and in each one of those that did reorganize, they were very unusual circumstances that generally do not exist.

Why should be care about whether or not retailers can be organized? In my view, the most important reason is that retailers are the employers of last resort. Indeed, when Circuit City closed its doors one day, approximately 30,000 people lost their jobs. You tell me, what type of jobs those people were going to be able to find when they were let go by Circuit City.

The question really is why has it created such harm, this amendment? A little background, more than 30 years ago, under the old Act, retailers did not lien up their inventory. If they borrowed money, it wasn't an asset-based loan. For some reason, starting in the late 70s, early 80s, the banks convinced creditors, the unsecured vendors, that indeed they were okay, the inventory can be liened up and it still made sense for venders to extend credit and they agreed to. Now it would be hard for you to find any retailer who does not have its inventory liened to the hilt.

How do the lenders lend on this? They have an advance rate. The advance rate is generally a percent of the cost or retail value of the inventory based upon what the lender believes it can liquidate that inventory for in the going out of business sale. That's a going out of business sale in the stores, not removing the inventory or giving it to a jobber or trying to sell it on the street corner. They know what they need to recover and they know they need to recover that in the going out of business sale.

Now we have the 210 day limit. What does that mean? First, the going out of business sale takes 90-120 days, generally, to operate to conclusion. You need 30 days or something like that, in order to get the court to approve a going out of business sale, a liquidation of the debtor. That's 150 days or so, 180 days, leaving, if you subtract that from the 210 days, it leaves you 60-90 days at the most before you need to move into a liquidation sale.

The banks who are lending and they know one thing, or they think they know one thing, that as of the 210th day, perhaps the debtor rejects the leases. Perhaps the debtor does not assume the leases that are necessary. They know or they’re afraid that on the 210th day, they lose an outlet or outlets in which to liquidate their inventory.

What do they do? It's clear. In almost every single instance, in fact, every one of the cases I've had which is more than a couple, the lender comes in at the beginning of the case before it’s filed and agrees to a DIP loan. What does that DIP loan say? It says, "You have 30-60-90 days to sell your company or to sell the assets and if you cannot sell it within that amount of time, you're going to liquidate this company. "

The DIP loans can get clever. Sometimes they don't have those particular milestones, the milestone might be that after 60 days, we're going to reduce your advance rate by 10% and after 90 days, we're going to reduce it by 30%, all of which create a circumstance in which the debtor does not have the ability to continue in business. They know that. That's what they want and they decide that before the Chapter 11 is filed. Those people who suggest, “Well, once you file, you can go to the landlords and negotiate with the landlords, get a little bit more time and perhaps we can extend it.” It doesn't work. It's not practical and it hasn't happened. The point is, it hasn't happened.

The lender goes into the case, it's decided that it needs to be out in 210 days, one way or the other. No if, ands, or buts and the momentum is created, the milestones are there, the covenants are created. No one's talking to the landlords. You don't have time to talk to the landlords. The lenders don't care anymore. They’ve made up their mind that they are going to liquidate this company or dispose of the assets before the 210 days expires.

The landlords, however much the landlords might be willing to talk, and indeed, during the recession I suspect they would have liked to talk more often than they did to the debtor and to the lenders, the lenders aren't interested.

What do we have? We have as you can see in that chart is that almost every retailer's assets are liquidated in less than 210 days. The vendors for the unsecured creditors do poorly and if the company is sold, it's generally sold at a 363 sale. The 363 sale in my view is nothing more than liquidation. The creditors get liquidation value. As you can see from that, the creditors do poorly so they don't have designation rights to monetize leases and the liquidation value is all the money that's distributed to unsecured credit.

Togut:

Larry, we'll come back to you. [*] Ms. Holland?

Elizabeth Holland: Thank you. Good afternoon Commissioners, fellow panelists, ladies and gentleman. My name is Elizabeth Holland and I appreciate the opportunity to testify today on behalf of the International Council of Shopping Centers on a number of issues that arise between shopping center owners and their retail tenants who have sought protection under the Bankruptcy Code.

I have sat on every side of this issue. As an attorney, I've represented retail debtors as well as retail landlords and financers of retail businesses. I was privileged to serve as a senior staff attorney for the National Bankruptcy Review Commission charged with making recommendations to Congress for amending the Bankruptcy Code.

For the last 15 years, I've been the C.E.O. of Abbell Associates, a 72-year-old commercial property owner, developer and manager of office and retail properties including enclosed mall and open-air shopping centers.

I have worked directly with all types of retailers, local, regional and national stores in good times and in bad times, stores that have successfully restructured outside of the bankruptcy process as well as within the bankruptcy process. I’ve also worked with stores large and small for whom bankruptcy was not a restructuring but rather an orderly liquidation of their business. As a result, I'm sympathetic to all of the constituencies interested in these issues.

The two issues I would like to discuss this afternoon are the time to assume or reject the non-residential real property lease and the treatment of stub rent payments following the filing of a Chapter 11 case. The BAPCPA 2005 amendments changing the time under Section 365(d)(4) from 60 days with four cause extensions, to a maximum of 210 days unless the applicable property owner consents to a longer extension, has been the focus of much attention, as Mr. Gottlieb very eloquently pointed out, in the wake of some very high profile retail liquidations, Borders Books, Circuit City, and Linens ‘n Things, just to name a few. I, more than anyone else in this room, would benefit in myriad ways if the only thing standing between a struggling retailer and a successful reorganization under the Bankruptcy Code was more time under Section 365 to assume or reject their store leases.

The fact of the matter is that the business of operating bricks and mortar stores has changed radically in the last 10 to 15 years. Internet retailing has shrunk margins as well as desirable store sizes, traditional inventory finance has changed in ways that's squeezed retailers and constrained operations and customers shopping patterns have shifted, changing the way people shop and how and what they buy. All of these forces and the speed with which new technology has brought them about made adaptation to the new reality a necessity for retail businesses to survive, let alone thrive.

In the face of these economic headwinds, some retail has been slow to adapt or unable to adapt or have simply found themselves in the buggy whip business. The dramatic downturn in the economy and the glacially slow emergence from that recession no doubt accelerated the demise of debtors like Circuit City, Hancock Fabrics, Movie Gallery and Linens ‘n Things.

Nothing in the bankruptcy code can make an unviable business model viable. The 2005 amendment to Section 365(d)(4) has done nothing more than to include retail property owners in the process of reorganization in a more meaningful way. In every one of the retail liquidation cases cited by the professionals on the other side of this issue, landlord support for extensions of time under Section 365(d)(4) was overwhelming.

The issue that has prevented each of these retailers from successfully reorganizing has been the lack of post-petition liquidity, due to onerous financing terms from DIP or exit lenders or loss of support from merchandise venders. It was the inability to finance these debtors as a going concern business following the bankruptcy, that has forced the liquidation of these businesses, not the inability to extend the time to assume or reject the lease.

The second issue I would like to address is the issue of stub rent, which is the rent that accrues between the filing date and the end of the calendar month when the filing took place and the treatment of it as a pre-petition amount due. Despite the fact that it is a pattern in practice in all retail setting to prorate everything down to the day of operations in a store premises, the Third Circuit in the Montgomery Ward case found that the date of billing determines when certain lease obligations must be paid. Timing the filing of the case to the first or second day of the month results in property owners losing rent and charges that accrue post-petition. In other words, during the stub period, before the next month's rent and charges are due.

These charges should be treated as administrative expenses like any other post-petition expense. Retail property owners, more than any other commercial property owner, incur more expenses per square foot on behalf of its tenants in the retail context. The Third Circuit ruling in Montgomery Ward falls hardest on retail landlords. This is one area where the Bankruptcy Code should reflect the pro rata pattern of practice in the commercial real estate industry and treat post-petition stub payments on a pro rata basis.

In conclusion, Section 365(d)(4) provides a balance between the needs of retail debtors to determine which stores to assume and which stores to reject and the needs of retail property owners to manage their business and limit collateral damage from a struggling or dark store. Regarding stub rent, the Montgomery Ward holding runs counter to the pattern of practice in the commercial real estate context and post-petition rent and charges should be pro-rated following the filing of the case.

Thank you.

Togut:

You are the only person ever in any of these hearing to beat the clock by 28 seconds. Thank you.

Keach:

It won't get you any leniency in question, though we do appreciate it.

[*]

Togut:

Mr. Pollack?

[*]

David Pollack: My name is David Pollack and I'm a partner in the Philadelphia office of Ballard Spahr L.L.P. As my written presentation indicates, the primary focus of my practice is representing landlords and retail bankruptcies and other related shopping center issues. However, I also represent tenants seeking to acquire properties and leases out of bankruptcy. Indeed, when I first came to Ballard fifteen years ago it was to the Real Estate Department, not to the Bankruptcy Practice Group, although I have since served as Chair of the Bankruptcy Practice Group as well as Partner in Charge of the Leasing Group.

The many issues which are troubling to landlords in the current interoperation of Section 365 of the Bankruptcy Code, as well as issues involving other sections such as treatment of landlords claims and the cap on unsecured claims, the proliferation of unfounded preference claims, which are nothing more than nuisance litigation, and the constant fire drills imposed on landlords, especially in the assumption and assignment arena. Many of these issues unfortunately cannot be addressed with changes to the Code.

As my presentation, however, indicates, I chose to address three specific areas. The first, the so-called 210 day rule of Section 365(d)(4). In particular, I do not believe, as opposed to my colleague, Mr. Gottlieb, that the change in that Section via the 2005 amendment has had any material effect on the ability to confirm real estate cases and further believe that the constant landlord bashing on this issue and other issues needs to stop.

I would like to read you a very short quote.

The debtors entered a Chapter 11 with reasonable expectation that they would consummate a Chapter 11 plan in a relatively short period of time. However, due to among other things, poor holiday sales, deteriorating business operations, the inability to reach a consensus with DIP lenders with respect to a long term business plan and the failure to meet certain other milestones required by the plan support agreement, the debtors in consultation with the steering committee determined that a plan was no longer feasible and agreed in an effort to maximize the value of debtors estates to pursue a sale of substantially all of the debtor’s assets on an expedited basis under Section 363 of the bankruptcy code. Although the pursuit of the Section 363 sale was clearly the best available means of maximizing estate value and creditor recovery due to the deteriorating value of the debtor’s estates, the DIP lenders would only consent to the debtor’s use of cash collateral on a limited basis.

This was not something written by a landlord’s council in support of maintaining the 210 day rule. Rather, these quotes are from the debtor’s counsel in Blockbuster, a case currently pending in the Southern District of New York and were filed just last Thursday [May 30, 2013] in a motion to convert the case to Chapter 7. The quote is exactly the point that I and Ms. Holland have also been making and that is, it is not the 210 day rule, it's the economy, it's the business plan, it's the lenders, it’s lot of different factors, but granting additional time is not going to save many or most of these cases. It didn't save Montgomery Ward twice. Montgomery Ward being cited as the case which showed how, if you keep the window open long enough, you can reorganize the case. They reorganized it and then they didn't reorganize it the second time around. Some things just die.

The other issue I raised concerns the interpretation of Section 365(d)(3) and the so-called billing date approach versus the actual or proration approach to debtor's fulfillment of their post-petition operations and issues concerning adequate assurance of future performance. I'm happy to address your questions with regard to these other Section 365 related issues or other issues not addressed in these papers that are of concern to the landlord. I see the green light is still on so that when facing the 210 day rule in the green light, you can reorganize.

Togut:

There you go. Mr. Keach?

Keach:

Yes, let me actually … I’ll pose this question for Ms. Holland but it's really for the panel. Both in your written materials and your remarks today, you've cited the financing difficulties of retailers as a primary cause of their failure. How do you address the point raised by Mr. Gottlieb and also, I would point out, raised in the Fitch rating study on retail bankruptcies that the financing difficulties are at least in part, a product of the 210 day rule. In other words, you have the count back phenomenon that Mr. Gottlieb referred to which is the lenders preserve the G.O.B. period at the end of their financing period, leading them to finance for 60 or 90 days with relatively onerous milestones tripping into a G.O.B. Isn't it in fact in part, the problem of the structure of the statute that's leading to the financing problems that you say are the root cause?

Holland:I don't know that that's necessarily the case. I think that there’s no question that the finance companies that go into very highly leveraged situations as Mr. Gottlieb noted that these retailers now have found themselves liened to the hilt, I believe was his phrase. Simply, that is the nature of the finance. These retailers are no longer owned by people who have their name over the doors. Their owned by investment funds and their owned by private equity groups who simply want to get in and want to get out, and there’s no real emphasis behind it as a going concern business.

I think that the DIP lenders who are using the 210 day rule as an excuse are simply using it as an excuse. I think that there’s no question that they don't really want to be in that business. If you look at the terms that even healthy retailers now can get to finance their inventories, it's not a business that is as profitable as it used to be and it used to not be that profitable. Black Friday was called Black Friday not because it was the worst day to drive by the mall but because that was the first day that that retailer operated in the black for that year and it was the day after Thanksgiving. You were operating in the red for virtually 11 months before you operated in the black. In retailing now, the margins have been shrunk by the internet, there’s no question about that. I had the privilege to talk to Jack Butler before we began and he thought that Circuit City should have made it. Of all the retailers that we talk about that have been liquidated since the 2005 amendments, he felt like Circuit City should have made it.

The question is then why hasn't a number two come in? The reason a number two hasn't come in is because that market share has been absorbed by the internet and internet sellers who can do it at virtually no margin relative to the kinds of costs a brick and mortar retailer has to sustain. I'm not saying that the finance companies aren't saying that it's an excuse but I think it is an excuse.

Keach:

Right. Let me just follow up and again other panels can jump in. Number one, if it’s an excuse, I guess my direct question is, "Why shouldn't we take the excuse away?" Secondly, one of the things you talked about and I think we would all agree with you, we can't do anything for retailers whose products are no longer acceptable in the marketplace. If you have a typewriter store, you're probably not going to make it. There are situations obviously that are exceptions but you did, I think, mention quite appropriately that adaptation is key to survival not only for retailers but for businesses in general. But don't we take away the ability of Chapter 11 debtor to adapt or change their business model or change their marketing model or change their product placement if we constrict the time in Chapter 11 to what effectively is 60 or 90 days? Don't we actually just contribute to that problem if we have truncated time periods?

Holland:210 days is a pretty long time for retailer who knows three or four months before they’re even going to file whether or not this store is profitable, whether it's on the margin or whether it's a dog. I mean, retailers know that day to day, week to week, month to month, so it's not as though this is new information that's being generated post-petition that they don't already know which stores are valuable.

I think to Mr. Gottlieb's point when he talked about designation rights and creating that value for unsecured creditors, there used to be value in these leases because they were below market leases. There were retailers who were interested in taking those stores back at those below market rents. I think that Mr. Gottlieb was correct, in the Montgomery Ward case there were stores that were able to come in and take those leases back and operate. There’s no longer that demand on the part of the retail community to take those stores back and those leases are no longer below market.

We're trying to create business opportunity within the Chapter 11 context, not only to reorganize debtors but also to create value for unsecured creditors, but that value is no longer there. I think that taking away the excuse is simply requiring people to operate within the time frames that they should be able to operate in.

Judge Gonzalez: If and when we get back to a situation where there is below market leases out there, hasn't the change to the Bankruptcy Code virtually eliminated the creditors from sharing in those proceeds? Because you're going to end up with the landlord, as you mentioned earlier, that now may be agreeing to extensions of time because they can't lease it to anybody else so you might as well cooperate with the debtor. When that phenomenon changes, if and when it happens, wouldn't the landlord just not cooperate any longer and try then to capture whatever below market value there is for themselves?

Holland:I think in those contexts, Judge Gonzalez, all you would need to do as the debtor’s counsel would be to decide very early in the case which leases you want to designate, which leases have value and which leases you can then assume and assign and retain that value for the debtor. There’s nothing about the 210 day window that prevents a debtor from doing things. They just have to do it more quickly.

Gonzalez:I agree with you, having provided over Petrie with I think 1,500 leases. How do you do that within the 210 days and how do you make a judgment as to what direction the debtor’s going to go in during that period of time and then decide which leases may be strategically important for that direction?

Holland:I worked at a big law firm and there are a lot of hours in a day and I think that [*]

you simply do it. No, I appreciate your concern and people talk about Sears and they talk about J.C. Penney and they talk about contexts where you may have this scenario that you described and in that case, I think you will have to do it more quickly, but I think that the value in those leases can be captured by the unsecured creditors. You just have to do it fast.

Togut:

Mr. Butler?

Jack Butler:Yes, I'd like to see if we can at least get on the same page as to certain facts, so I'll just start with you, Mr. Pollack. If you draw a line in the sand as when the BAPCPA amendment became effective and look at the eight years post and the eight years pre-, would you agree with me that the reorganization success rate has dropped dramatically in retail cases post-BAPCPA as opposed to pre- without regard as to why? Just a “yes or no” really, I want to get your sense.

Pollack:I would not agree with that and I would say that it has dropped but I don't think it's dramatically as you think it has when you look back at the pre-2005 cases and the number of those cases that liquidated on a regular basis so yes, I agree that there has been a drop but I don't think it's as precipitous as you would surmise.

Butler:

Ms. Holland? Same question.

Holland:It has dropped, yes, and it is due to market forces outside the effects of the Bankruptcy Code.

Butler:

We can debate as to why it did it and I know you would argue. The witnesses are clearly not in agreement in the why, but I just want to see if we can get some basic agreement, even from Mr. Pollack who admits there’s a drop. He'll just argue about the rate of decline, but there was a drop. That's point number one.

Then I want go back, Ms. Holland, about something you said about retail cycles because I grew up in a retail family. We had department stores. I was a stock boy when I was nine years old, illegally I guess, and I sold suits when I was eleven and worked in the family department stores of the late 60s and 70s because that's what you had, you had family department stores until the malls came and wiped out all the family department stores across the country, right?

As people went through the various restructurings whether it was from family department stores to malls to category killers to the evolution of the retail chain. Retail cycles are important, wouldn't you agree in all of those things? When you're trying to fix a retailer, isn't it true that you actually want to try to put in a marketing plan, you want to change things around, you want to have to test those things.

In the concept of actually trying to rehabilitate retail, how is it that 210 days, less than one season perhaps, how is it that that is a lot of time? I'd just like you to explain your earlier answer because I don't understand it.

Holland:My answer was to the time to analyze the value of the lease. It wasn't the time to reorganize the retailer, implement the type of changes that you're discussing, a different marketing plan, a different roll out, a different way to draw customers in. I think that to your point, a retailer has 210 days currently to decide which stores they want to implement your plans on and those are the stores you should assume, those are the leases they should assume.

Butler:

Putting aside the 210 days, wouldn't you agree if you argue for a moment to the goal, the one goal of retail reorganization ought to be to actually reorganize the retailer?

Holland:Absolutely.

Butler:

That you actually have to give that business an opportunity to recalibrate to take its breath and figure out what to do and then to actually test that and because lenders, exit financials, want to know that it works, right?

Holland:No question about it. [*]

Butler:

How do you do that in the time frames we set up in the Code?

Holland:You need to decide which stores you want to do that in and I think that information has been available to the retailer for years and years prior to the filing, certainly in the months prior to the filing and they know which stores that your shift in approach is likely to be successful in and that's their time to decide.

Butler:

Ms. Holland, one last question and I'll give Bob back the floor. In the world I grew up in, looking at retail, it's not that black and white. You generally have, across an array of stores in a chain, a group of stores that perform traditionally well, a few that are dogs that don't perform particularly well and there are reasons that people keep those stores around including deals with their landlords to keep them around. [But] there’s a lot in the middle that one year to another, one cycle to another, flip back and forth. The concept that you would argue is that you know with precision how in a rehabilitation plan, how that's all going to shake out. Is that really connected to reality in your judgment?

Holland:Oh, I think it's absolutely connected to reality and I think that if you're a good merchant, you stick to your knitting and you know what you do best and you focus on the stores where that approach is going to work. The perfect example now is what’s going on at J.C. Penney. I think J.C. Penney forgot who their customer was and they brought in somebody who’d done amazing things at Target and amazing things at Apple and then realized that the people who shop at Target and Apple don't shop at J.C. Penney. Now, they’ve brought Myron Ullman [III] back who is very good at what he does and he sticks to what he does best.

I'm simply saying, Jack, that the things that you need to focus on and the things I think the finance community will reward you as a debtor in possession is the ability to focus on where your strategy can be successful and you will have a much greater likelihood of success implementing a narrow focused strategy and a narrow focused way, than you will I think in the approach that you're talking about where you need a lot of time to decide what that big middle swath is going to do.

Togut:

Okay. Jim Millstein?

Pollack:Can I just address that last question for a moment? I'm glad you're sitting down, Jack, because I agree with you to a certain extent, that there are in fact some retailers that need that additional period of time, but I think everybody is passing over the fact, and putting aside Judge Gonzalez' point for a moment about today's marketplace. The landlords aren't all stupid and they don't necessarily need to wait until sometime after a case has been filed to reach agreements.

I'm going to give you two examples. In Circuit City, we, and I was one of them, went to debtor’s counsel in advance of the filing and immediately after the filing. It was filed in November. We said to counsel. “We will give you an extension. We think you probably want to see what next Christmas looks like. We'll get you those extensions and we will help you get extensions from those who don't represent multiple landlords.” The response was we don't need it right now and then when the case tanked in February, the response of counsel to the court was, "We're sorry this case is going down the tubes but the lender won't lend without trade support and the trade won't give trade support without the lender.”

It wasn't the 210 days and if the lenders had listened, they would have had the time. Linens ‘n Things was the same thing. In Linens ‘n Things, after the first G.O.B. sales, Linens ‘n Things hired D.J.M. to go to the landlords and they told us that the lender said you need 80% of the landlord to agree to an extension of time or we're not going to lend any more money. D.J.M. got 92% of the landlords to agree and the lenders said, "We don't care," and went away.

There are things that could be done. I hate to mention this but we see leases come in now where the lease itself has a provision granting an extension beyond the 210 days. In Movie Gallery, and what I think was a ridiculous result but they did it anyway, checks went out to landlords and if you cashed the check, you were considered to have agreed in writing to an extension of time to assume or reject.

There are multiple ways to skin that cat and it's not just the 210 days but the lenders have to agree as well and people have to be willing to go to those lenders to ask for that time.

Togut:

Okay. [*]

James Millstein: I haven't done a retail case in a long time and I was actually amazed by the stats in Mr. Gottlieb presentation on the success since the amendments and I'm very curious. I agree with you about what you said about the retail environment and the impact of the internet, but the other thing you said I think argues against it, which is that Black Friday is the first day that people make money in the retail business so if you're unfortunate to have filed 210 days before Black Friday, you'll never have a chance to see whether or not the strategies that are going to be implemented will succeed because most retailers only make money one month of the year, which is the end of the year.

It seems to me that what Larry is saying and I think you guys are actually, by your own testimony, affirming there’s an interaction between the statutory Code provision and what lenders are prepared to do. Lenders structure their financing around those [Code] provisions, creating a higher hurdle for retailer to actually keeps its assets and test its markets in the period of time that it is required, which in a retail business, a very competitive environment to make a go of it, is December.

If we're cutting off a retail debtor from the ability to get to December, it has no chance, by your own testimony. I think that's the thing we're struggling with as a Commission is how do we dictate the realities of the financing market which is that everyone's liened up to the hilt and that lenders structure their loans around legal requirements.

If you know that your assets of your borrower can be forfeited by the Bankruptcy Code 211 days out, of course you're going to structure your loan to require that the realizable value of your assets happens before day 210, therefore cutting off the prospect of reorganization. I really think it's a problem and I think you’ve conceded the problem for retail businesses in particular because they need to get to December or they have no chance, in a retail environment that is operating on an even thinner margin than they ever operated on before.

Togut:

Don Bernstein?

Don Bernstein: Yes. This sort of follows up on what Jim had said but perhaps in the form of a question. Based on your testimony, especially David's about situations where the landlord have been willing to extend, because right now the ability to re-let stores is very difficult, isn't it true that this provision is actually operating against the interest of the landlords who would like to see that next Christmas season and perhaps continue to have a store that's open as opposed to one that's gone dark?

Pollack:I think that if that were the case, we'd be hearing from our clients saying, “We want you to extend the time, we want you to extend the time.” We're not hearing that. What we're hearing is we want to know what's happening with the property.

Admittedly, as I said, there are some cases where you need to get to that next Christmas. You need to do whatever. That's not every case. We're talking about reorganization, and as I've said in my paper, I use that term a little bit more broadly than just a reorganization of just that particular debtor because I think 363 sales today are yesterday's reorganizations in many cases. Eddie Bauer's a perfect example.

Eddie Bauer went through a first bankruptcy and went through the second bankruptcy. In the second bankruptcy, you go out here today, you think you still have Eddie Bauer, but it wasn't, it was a sale. You see that in any number of cases where you have sales but then you see the failures, too. Any number of the cases has failed.

I went through Larry’s chart on the train on the way up and there are, in my mind anyway, reasons for each one of these cases where they didn't reorganize and I said in the paper, if you look at, for example, big boxes, the number two in the category is gone. Linens ‘n Things is gone, Border's is gone, and Circuit City is gone. Why are they gone? It's not because of 210 days. If it was the 210 day rule was such a problem, then why did Montgomery Ward die after two bankruptcies with all the time in the world? They had all the time in the world, but didn't make it. Maybe that's the reason some of these other's didn't make it.

When I go back and I look at what has happened, I think that in the appropriate case, you’re going to get that time to see that extra season and if the market changes and things happen, the landlords find that they want more time, they’ll go to people in advance. We get calls in advance. We get the D.J.M.s and the Hilcos and the Great American’s or whatever saying, “Landlord, these guys are really hurting. They need time, they need rent relief,” et cetera, et cetera. They’re negotiating that in advance. This is not happening on the first day of the case but if you take it away and we go back to the old rule where an extension for cause meant filing a motion, then where are we?

Togut:

Okay. Rich Levin?

Rich Levin:I want to give Mr. Gottlieb a chance to say a few words. [*] I do have a question for you, but I know you wanted to say some things. I have a question for the other two witnesses but if you keep your answer brief, I'd like to then turn back to them. Go ahead with what you wanted to say and I'll have a question as well.

Gottlieb:I will be brief, so first, let's be clear, this is not landlord bashing. Seriously, I wanted to respond to you humorously about it but on the other hand, this is not an issue of landlord bashing at all. To me, it's an issue of balancing the equities to a certain extent.

The landlord gets paid if there’s an extension or not. In my view to say that retailers really can't reorganize. Please remember since 2005, there has been an up cycle and a down cycle. 2005 and 2006 were good years. No retailers reorganized although they filed during that time period. I would be willing to submit to this committee, if you want me to, a chart that would show you how many retailers reorganized before 2005 and how precipitous a drop was after that, that none have reorganized since then.

Then, just to point out that Macy's and Federated and Stage Stores and all of you can go through a lot more cases than I can, took two and three years to reorganize. What happened in those two and three years? They worked on business plans. Stage Stores, I remember because I was involved in that one myself, went through three business plans. If they had rejected stores after their first business plan failed, they would have never come out of bankruptcy and yet they now exist as a successful public company. As we know Macy's is as well.

I think that you can't blame it on the cycle and the point that was made by Jack about the ups and down cycles is there, it always is and to expect that a retailer can know what to do and to test out a new business plan and do all of that in 210 days so that the lender feels safe that it can liquidate its inventory and get paid, if it has to, it’s not realistic, it’s not practical.

Togut:

We'll take that chart.

Gottlieb:I'll do the chart.

Levin:

Yes. You pretty much answered the question I was going to ask you so let me turn to your co-panelist there. One of the things we find in looking at cases and the behavior of creditors is every counterparty from the debtor, secured lender, unsecured lender, lessor, intellectual property licensor, pick a category, wants to control his own destiny in the case. One of the complaints that has been leveled against the current Bankruptcy Code, justified or not, is that secured lenders get to decide whether the case lives or dies. They have their hand on the switch or they get to pull the plug however you say it and they have way too much control, some people have called it 'creditor in possession'. I'm not trying to agree or disagree with that, I'm just describing.

The 210 day provision seems to me, inconsistent. Even though landlords can say, "Yes, we'll extend," the landlords are essentially saying, "We want that same right to control." I have two questions coming out of this premise. One is, who should decide whether a bankruptcy case continues to attempt to reorganize or terminate? Should any particular creditor group have a veto power? That’s one question.

Second question is, I think you're going to have to agree with me that 210 day rule is a pretty blunt instrument. It's not nuanced at all. I'm not sure what the landlord community is seeking to achieve with the 210 day rule.

Mr. Pollack actually, I sat in on the advisory committee meeting where he gave some views on that and I think it'd be useful to share them with the Commission here and that's why I'm asking that question. What is this blunt instrument designed to do for landlords that a more flexible instrument couldn't do equally well, assuming that we fix 365(d)(3)? [An instrument that would] provide that landlords do actually get paid post-petition for everything that they’re due?

Those are my two questions relating to your position.

Pollack:I'm going to yield on the second question to Liz because she is the owner and she can tell you why she needs 210 days. I can tell you what the background was but I think somebody who actually owns and is trying to make money in that industry is better at answering that question.With regard to the question about should any one group have the right to veto, I would say no but everybody wants to at least have their iron in the fire, whether it is the 503(b)(9) creditors or the utilities or the alleged critical vendors who are getting paid pre-petition money, not knowing if administrative creditors are going to get anything, everyone wants their iron in the fire. I agree. No one party should [have control]. The question is how do you balance all those irons in the fire to make sure that people who should have the say do have the say but nobody can control it jointly.

Levin:

The 210 rule does give the landlord a veto, doesn't it?

Pollack:No more than some of the others.

Levin:

Yes.

Pollack:Yes, just not more.

Keach:

The problem is not that the iron is in the fire, it's about what people are doing with it when they extract it from the fire, that is the problem.

Before Ms. Holland answers Rich's question, I just want to amend it with another consideration because he asked you about what if we fixed it so that everything had to be paid. To me it goes back to Rich's earlier point which is who gets to decide the question. You asked Mr. Pollack, “Where are we if we go back to the old rule?” Where we are is the bankruptcy judges get to decide this question, taking into account a full range of interest as opposed to just your interest. If you had Rich's condition and another, which is that bankruptcy judges were instructed to take into account potential prejudice to the counterparty in these cases, which is something that I think under the case law previously they were not, would that make a difference in addition to his payment option?

Levin:

To be clear on my question, though, I'm happy with Bob's addition to it but my point is what are you trying to achieve? What is the goal here that this blunt instrument was directed to and can it be done more effectively for both sides?

Holland:What we were trying to achieve is the preservation of another going concern business and that going concern business was the relevant shopping center. I think that what the 210 day rule created was that it used to be 60 days before the debtor had to come in and say to the court what they wanted to do with their unexpired leases and now its 120 days before they have to come in and explain what they need to do. The additional 90 days was so that they could have some extended period of time but at a certain point and I think that the facts that we all keep using are ones where the store is open and it's operating and the debtor is implementing in good faith the kinds of plans that Jack talked about. In many instances, the store is dark or the store is not attempting to implement plans,

Levin:

But 363(d)(4) requires compliance with all the terms of the lease. The dark store is not compliant.

Pollack:No, except that Macy's says that it is.

Keach:

But again, we're rewriting things.

Levin:

So if we have a compliant store, how does a paying operating store, that’s in bankruptcy and still has customers coming to and from the mall, damage the mall business? What other than that, because I don't think you can say it does, so what are you trying to achieve?

Keach:

This is my point. If we could take away prejudice, if we could write this so that the contagion kind of issues you’re worried about within the shopping center could be managed. In other words, the bankruptcy court had to take into account as part of the cause showing and absence of prejudice to the property owner and combined with the payment issue, wouldn't that solve the problem and leave this to the discretion of bankruptcy judges as opposed to the discretion of landlords?

Pollack:Once you have a debtor who files, particularly if it is a large tenant and I mean by that, a large occupancy space in the shopping center, you have any number of additional issues, the first of which is you have to deal with your mortgagee.

When you have a filing, you have various responsibilities. When we have a filing of the big company, my SEC-restricted clients have reporting that they have to do and these things go on. Lenders look at them, they have reports to stockholders, all of these things go on and the longer it goes on, these questions arise all the time.

The second part of it is that everybody assumes that if somebody rejects a lease, you go out and find a new tenant, no big deal, maybe in today's market it takes a little bit longer but even in the good market, there’s something called the leasing cycle. That is how long does it take to lease up a space. It's not just finding the space, it's negotiating the lease. It's building out. It's the time frame of the tenant because the tenant, especially tenants in the rag business, in the clothing business need lead times of sometimes six to nine months to order goods from their Asian suppliers so they’re not going to open a store they know they can't get goods for.

We have tenants that we represent and we represent the landlords who lease to them who only open their stores during certain months of the year and one tenant, one large retailer I have only opens three days of the year. The open all of their stores the same day, so it's not as if you can just turn around and do magic and put somebody in.

Not knowing is the problem because you can't book ahead. These people book spaces that they’re going to open two or three years down the line when all of a sudden you're in flux with this, it creates problems, and the 210 days tends to give you a little bit more certainty then you have otherwise. It tends to, from this end, calm some of the fears you have on financing market.

Togut:

[*] Okay. Jan?

D.J. Baker:Just to follow up, I was going to ask the question Bob Keach asked which really relates to the fact that the lot of the criticism of the Bankruptcy Code currently relates to the different amendments that have progressively stripped discretion from the bankruptcy judge to make decisions, particularly with regard to time periods within which to make decisions.

I think I heard an implicit no to the question, but just to be clear, would David or Liz support, under any circumstance, a modification of the 210 day rule that restored discretion to the bankruptcy courts with all of the provisos suggested by Bob and Rich?

Holland:Unfortunately, because I have tremendous respect for the bankruptcy bench, unfortunately I think the discretion that was in certain instances not used with a great deal of discretion [and] resulted in cases where at the first expiration everything was extended to confirmation. [*]

I think unfortunately, and I say this with a heavy heart because I do have tremendous respect for the bankruptcy bench, [judicial discretion] is probably not going to help anyone who is on the other side and needs the certainty that Mr. Pollack described. It's very, very difficult to operate a business when a good portion of your ability to move that business in a positive way and with positive momentum [is hampered]. [With] these assets, particularly in the enclosed mall context and you see it all the time, it's like the Queen Mary. You either have positive momentum or you have negative momentum but you're not standing still for very long, so I think that while discretion can be a good thing in certain instances, I think unfettered discretion would be a bad idea in this context.

Baker:

Just to push that, if there was not unfettered discretion, if there were burdens, presumptions, et cetera, is it fair to say that on balance, you would still oppose restoring discretion to the bankruptcy courts?

Holland:It would depend on the burdens and the presumptions. I think that the benefit has to run with the proper burden in this context because in retail or any type of landlord is really the only compelled creditor that has to extend credit to the post-petition entity without post-petition terms and I think we all have to be cognizant of that.

Togut:

We only have a few more minutes and at least two other Commissioners who want to ask questions. Bill?

Bill Brandt:Ms. Holland, it's not entirely a landlord-bashing group. I’ve been an I.C.S.C. member for almost 38 years, so there’s some presumption here that the landlords have some platform from which to speak. I was involved in BAPCPA, you may recall, and I have a political viewpoint on it, that 210 days and 365(d) resulted from perceived excesses of some of the debtors, not just the extensions but the sale of designation rights or the marketing of leases in a wild number of ways.

Effectively, I look at 210 as a way to cut that off and as I think as Mr. Butler may have said, the balance of the equities got out of whack. My question is simple. Would the landlord community agree to think about something of a give in the 210 area if we could do something with respect to the older perceived excesses that involved in the sale of the leases or involved in designation rights that perhaps caused them to react with such fury at the time of this particular amendment?

Holland:I do recall your involvement and I think that there’s no question that the Bankruptcy Code has to strike a balance so, to the extent that this Commission is committed to continuing to try to strike that balance then certainly the landlord community would be happy to review anything that you have put forward. It’s hard for me to say unequivocally yes, since I don’t know what those balance in issues are to Mr. Baker's point.

Brandt:I was following up on Jan's point and that is I think the consensus is even among those who are predisposed to be slanted the landlord’s way, that perhaps the hard stop of 210 has created unintended consequences. There are always manifested latent consequences. If we could come up with some other means of dialogue with the landlord community which might assuage some of the other issues that happened before this was put in place. Is there room for maneuvers is my question.

Holland:Absolutely.

Togut:

Okay. Hal?

Harold Novikoff: I think one of the problems that we're talking about here is that the 210 [day rule] really acts in a very blunt way. On the other hand, I can understand where the landlords are coming from. From past practice, I think, David, you put it this way - your client wants to know when they’re going to get the property back. But is one element, in trying to create a balance, in essence giving the landlord some comfort that if the extension is going to go past 210 days or some other period of time, whatever the right period of time is, that the landlord then has some period in which it knows it's going to continue to get rent.

You don't have a situation where there is simply an extension and the debtor can then terminate on 30 days notice but at that point would have to terminate on a longer period as a way of helping to balance the burden so there’s some period of time in which the landlord knows it will continue to get rent or at least some period of time in which [the landlord] will know that it's going to have available in order to market the property, even though it may not know precisely when it will get the property back. I'm just looking if that's a way to try to create some balance.

Holland:No question. As somebody who had to work with Allstate when we had a dark Montgomery Ward store, there’s no question that the type of option extension that you're describing would assuage the concerns of those lenders. Where it wouldn't make a difference, would be with the rest of the tenant base who would either not extending their own leases, terminate, or decide to go to percentage-only rent because of the lack of an actual anchor there, in the case of Montgomery Ward. So I think your proposal would certainly address the concerns of a lender in that context, it would not address the concerns of the other tenants.

Togut:

Okay. Thank you. Jack?

Butler:

Yes, I just want to follow up something you suggested which I think Mr. Gottlieb said he was going to submit a supplemental submission. I was going to ask, with leave of the Chairs, that since this is such a terrific panel of witnesses representing the points of view, is that one, to the extent that on the dataset you would be willing, the three of you, to work together and submit a joint supplemental submission that you all agree on or try to agree on in terms of what the facts are. It does trouble me a little bit that we can’t agree on a base set of facts, [like] how many reorganizations there have been, I would love to see a joint submission, if you would be willing to undertake it.

Then, following up on Mr. Baker’s question, I would appreciate any supplement submissions you would be willing to make that would talk to the criteria, the burdens, or the way in which discretion could be fashioned in something other than what it currently is in the statute. Because I think that there are at least some of us who are trying to balance a lot of issues and trying to sort out whether there is a place to get to that properly takes into account all of the economic interests in place, but is not, as Mr. Levin called it, the blunt instrument that maybe we have today.

While I appreciate the testimony we've gotten to date, the testimony doesn't help problem solve from my perspective. I would love, to extent that any of you are willing to help with it, see some supplemental testimony from the experts we have here on the kinds of issues we should be thinking about.

Togut:

Let me echo that. That would be really helpful. Bob?

Keach:

Yes, I've got one question that I think requires really short answers. I'd like to hear from everybody on the panel. [*]

Number one, I guess the first half of the question is would you agree that the BAPCPA provisions essentially killed the designation rights market?

Secondly, if you agree with that, would you agree without judging it one way or the other, that he effect of the death of that market is a transfer of value from stakeholders of the estate to the landlord?

Gottlieb:All right. I'll go first. Yes and yes.

Togut:

Thank you.

Holland:No and no.

Keach:

Let me follow up. I'm interested in the no part. Do you think there’s actually a market left or that BAPCPA didn't kill it?

Holland:I think the BAPCPA didn't kill it. I believe that market died but I believe it was due to another disease, not BAPCPA.

Keach:

Which disease?

Holland:The fact that the leases in question are no longer below market leases.

Levin:

If they were above market leases, would there still be a designation market?

Holland:No, because who would want to buy a below market lease?

Levin:

I'm sorry. I said ... If they were below market leases. [*]

Holland:Yes, I believe there would be a designation market.

Levin:

Even with the 210 days.

Brandt:I would argue vigorously the other way, having been there. Even if they were some locations that pure market is still valuable for other people whether high or low but I saw, I was in those negotiations, this 210 day hard stop effectively killed designation rights and that was the point and it worked. What I'm suggesting is perhaps it worked too well and maybe there’s a way to rebalance this.

Keach:

Mr. Pollack, in fairness, you should answer this question and then we should move on.

David:

My discussion with two of the people in that business immediately following the passage of the 2005, was that the amendments were going to seriously cut back on designation rights but that where there was value, they would still be involved. That involved among other things whether or not somebody purchasing designation rights was willing to take on the liability that they would have for two years’ worth of administrative rent and then an unsecured claim based on a delta between the value of the property and what it was. They said they would still be in the market. They wouldn't be in the market as heavily.

Where we still see designation rights right now is not for some third party but where a 363 sale occurs and the buyer, instead of taking assumption and assignment of the leases, now designates all of the stores, hires some outside agency to try and negotiate rent relief or whatever and then decides some time before the 210 days are up, which leases to designate to assume or reject.

In answer to your questions, yes, I think it didn't kill the designation rights but it significantly cut it back. I think the second answer is no.

Togut:

Okay. I want to thank the panel. I think we could have gone the rest of the day just talking about this topic. Additional submissions will be greatly appreciated. As you can see, we're struggling with this and any help you can provide to us, will be deeply appreciated but let me thank you. You were great.

Keach:

Yes, incredibly helpful.

Togut:

Thank you. Okay, so next up is the intellectual property panel. Welcome. I said before that we have this light system here. I don't know if you can see it. Green, you got five minutes. Yellow start wrapping up and red, you're done so when it goes on try to finish the thought and move on.

The second panel consists of Robert Eisenbach of Cooley L.L.P., who came in from San Francisco, we appreciate that. Lisa Hill Fenning, from Arnold & Porter, came in from L.A. and Jeff Wurst from Ruskin Moscou, who came in on the Long Island Railroad. We appreciate you being here.

[*]

Togut:

All right, we’ll start with Mr. Eisenbach.

Keach:

We're very linear, so we'll go left to right.

Robert Eisenbach: All right, thank you. Thank you to all the Commissioners for the opportunity to speak with you. I'm Bob Eisenbach. I am at Cooley L.L.P. in the San Francisco office and have for 20 plus years represented companies in Silicon Valley and elsewhere around the country, committees in technology and also retail cases and purchasers and sellers of distressed assets and distressed M&A transactions. Included in all of that has been the representation of licensors and licensees of intellectual property.

I want to address four key issues that I think are pressing issues in the intersection of intellectual property and bankruptcy law and those involve two circuit splits, one where the debtor is the licensee and the other where the debtor is the licensor, and the issue about what consent really means in [Section] 365(c)(1). Finally, some definitional issues that have particularly arisen in the 25 plus years or so since the enactment of the 1988 Amendments that added Section 365(n) to the Bankruptcy Code and along with it Section 101(35A) as it is presently numbered, the definition of intellectual property and bankruptcy.

Let me just first address the circuit split where the debtor is the licensee, the recipient of an inbound license from an intellectual property owner who is not in bankruptcy. This is the circuit split that is arises because of the interpretation of Section 365(c)(1) and in particular, the first five words, “the trustee may not assume or assign.”

What does that really mean? I think you alluded to this in your opening remarks that we've got different circuits coming out differently on the meaning really of those words and how this plays out. We've got the hypothetical test circuits when the debtor is seeking to assume its own inbound license, not to assign it to a third party, simply to assume it. Does the debtor get to keep that license or not, if it can cure defaults and provide adequate assurance of future performance? The way the hypothetical test circuits, essentially the Third, Fourth and Ninth [Circuits], have read that, the answer is “no,” not unless the licensor consents. I believe that that is not good for reorganizations. It's not good for debtors and I think it goes a little too far in the balance between what licensors are entitled to.

[*]

I don't think that's a fair balance between the rights of the licensee who's received a license pre-bankruptcy from a licensor to face the prospect of without obtaining consent one way or another or perhaps failing to get that consent. We’ll simply lose the license because it's chosen to reorganize in bankruptcy, so my recommendation would be to permit a Chapter 11 debtor in possession to change Section 365(c)(1) or at least the outcome of it. Perhaps statutory language can be placed elsewhere that makes it clear that a DIP in a Chapter 11 can assume its own inbound license if its otherwise able to meet the test under Section 365, essentially curing defaults and providing adequate assurance.

I think that's the right balance and really isn't shocking to a licensor that its debtor is going to retain that license for the full term of the license or a perpetual license if it happened to be issued in that a fashion.

The second circuit split is a new circuit split. After 27 years, since the Lubrizol decision in 1985 out of the Fourth Circuit, the impact of rejection is now a question mark. The Seventh Circuit’s very interesting decision in the Sunbeam case last year has really raised many questions about what is the impact of rejection, what does [Section] 365(g) mean and it has chiefly come up, not surprisingly and I'll comment why in a second, in the trademark license area. The lack of surprise there is because trademarks are not covered by Section 365(n). They are not included within the definition of intellectual property in 101(35A), as a result, there’s no [Section] 365(n) protection.

So, trademark licensees have for 27 years been very worried that there are licensor debtors in a bankruptcy [and they] or a trustee may reject those licenses and under Lubrizol, [any trademark licensee] may lose their rights. I think that should be addressed by essentially restoring [the rule under] Lubrizol and if [Section] 365(n) needs to be amended, take that issue up.

A very brief mention of the other two issues as I wrap up, which is consent under [Section] 365(c)(1)(B) ought to include and clearly include consent either to assumption or asssignment or both, if that consent is provided in a pre-petition agreement, likely the license agreement rather than have a question of whether it only has to be post-bankruptcy consent that works.

Finally, the definitions in 101(35A), particularly of patents and of patent applications, I think should be amended to make very clear that foreign or non-U.S. issue patents and patent applications are covered. I've seen some strange things being proposed in license negotiations to deal with the question mark around that. It's not necessary and the world has changed since 1988 and there are many, many, many global patent portfolios and patent application portfolios, and those need to be covered clearly in the Bankruptcy Code.

Thank you.

Togut:

All right. Thank you.

Lisa Hill Fenning: I'm Lisa Fenning and speaking with several hats but ultimately the opinions I give here today are only my own. I speak from the experience of having sat as bankruptcy judge, been a practitioner for many years. I've also submitted a written statement today that reflects mostly my own practice and some suggestions based on that. Also I've been working with the advisory committee and then substantially, but not entirely responsible since I shared the thoughts of many of my colleagues in connection with, contributed to the report that has been generated by the advisory committee.

My concerns are overlapping with Bob's. My representation is primarily of the non-debtor licensors and licensees who have to deal with the uncertainties that the current body of law creates. My colleagues, who are transactional lawyers and trying to document deals, raise all sorts of questions about, "Well, if I understand the Bankruptcy Code correctly, what can I do to protect my interest in the documentation of a deal?" and the answer is, "Well, you can try this," or, "You can try that and that depends on where they file the bankruptcy,” and that's not a satisfactory deal answer.

I agree that the hypothetical test needs to be addressed; it should be eliminated where consent has been given pre-petition in the contract. I agree with Bob on that. There is, however, a serious issue that remains and it can't just be eliminated entirely because sometimes a reorganized debtor bears no reasonable relationship to the pre-petition debtor. To say that allowing assumption without some kind of consent requirement, especially where brand issues may be involved for the licensor, it goes too far.

If the post-petition reorganized debtor ends up being owned by a competitor, by an entirely different group, goes off in a different business direction and all of us know there are many cases where you know that happens, then it is not fair to say that that is the bargain that the original debtor licensee made and that it's fair to require the licensor to accept that licensee post-effective date.

Some consideration needs to be given to allowing the continued effectiveness of change of control of restrictions built into licenses. Some licensors don't care if they’ve consented to assignment. If they consented to assumption by merger, a transfer and that sort of thing which does appear in many licenses, that should be binding, post-petition.

I agree with Bob that the fact that somebody has consented pre-petition as a licensor should be binding on the post-petition. There’s no reason to take away consent that's been given, however many contracts now, licenses, assume that they have the power in the bankruptcy case to withhold consent, so they give consent if their documents today on the assumption they can say not if there’s a bankruptcy filing. There needs to be some sort of consideration given for grandfathering if that kind of change were to be made to allow people to conform their drafting requirements if indeed they do want to restrict post filing assignment or assumption.

Now, you say, "Well, won't everybody put into their licenses that they can't be assumed or assigned?" and the answer is no. That will go into a lot of them, but in many cases, this is a commercial transaction that's bargained for and people can bargain for the right to assume, assign, be allowed to merge, do other kinds of transactions and retain their license rights.

The second major issue has to do with [Section] 365(n). That is a problematic section for several reasons. It's under inclusive. It's under inclusive because it leaves out protections for foreign patents. It does not protect the holders of trademark patent and trademark licenses, and it does not protect the prenumbra of intellectual property rights that include rights of patent prosecution, patent litigation enforcement rights, consulting rights, know-how interest, all sorts of rights that have now been built in around the licensing area. That suggests revision to not only [Section] 363(n), but also more importantly the definition of intellectual property and an expansion of that definition could cover that universe.

It's also under inclusive in another respect. Sometimes debtors acquire portfolios of patent from predecessors. They don't assume obligations but those patents may be subject to licenses at the time that they are acquired. The question is what happens if the debtor then turns around and sells those patents in the course of a bankruptcy case. The answer is, "Well, it depends."

In most situations, the debtor will say, "I'm not in privity." There’s no assumption of rejection involved because there’s no contract with the debtor and therefore, the licensee can say, “I had a license from company A who sold the patents to the debtor, the debtor is now selling to company C. Do I still have patent rights, license rights against company C?” Under patent law, the answer would be yes, because the bundle of patent rights that can be sold, has been limited by the rights that were transferred previously.

There’s no good reason under bankruptcy law to change that because the debtor should not automatically acquire more rights just by virtue of filing, that if the universe of rights and that patent shouldn't expand and therefore [Section] 365(n) should protect all prior licenses. What those licenses are don't have to be determined by the bankruptcy court, it's just whatever they happen to be, they still are and the buyer is subject to its licenses.

I note in my written testimony there is some mechanical issues that could limit the need for litigation just procedurally but I'll rely on my written testimony for that.

Togut:

Thank you.

Jeff Wurst:Good afternoon. First of all, I'd like to thank the Commission for taking time out of the day for the New York Institute of Credit. We're pleased to have you here and we're pleased to be able to host you and that's probably the segue to why am I here. The invitation came from Sam [Gerdano] after I guess he saw an article I had published and because I'm off topic, I'll try to be a little more brief.

Keach:

You're not off topic. You're just your own topic, Mr. Wurst.

Wurst:

That's fine but it seems we're talking about intellectual property, maybe an avenue I don't necessarily belong in although I've represented lenders who have gotten out of difficult situations only because they were able to sell products like names like Schraffs and Barassini and things like that.

Togut:

Yes, but you have a smart topic, very intellectual.

Wurst:

Yes, but the reason I'm here is really to discuss motherhood and apple pie. Forgive me if I haven't followed all of your proceedings to see how far you've gone into these topics. They know from Mr. Togut's remarks earlier that you have addressed this but I think the issue that appears to me to be the most significant issue we face in bankruptcy practice is preserving. The most important issue is to preserve the quality of the judiciary. In this part of the world, we have lost excellent judges. We lost a chief judge in a neighboring district. We have judges who practice in this district, who are faced with the dilemma of providing for their family and putting the kids through college or leaving to return to private practice. That is, I think, the foremost issue we face. All of the substantive issues that you're dealing with are certainly important, but no matter how we resolve those, if we don't have competent and qualified judges, all of that effort is a waste. The simple message is we cannot afford to lose judges because they cannot afford to remain on the bench. That's that point.

The other issue has to do with the other side of the spectrum and that has to do with the affordability of the process and that was with the article that I wrote that I was asked to write by the ABF Journal addresses. We spend so much time, especially in this district looking at mega cases, it's nice to have the Delphi's and G.M.'s and it's nice to be a court of choice for very large cases, but most of us grew up handling smaller cases and handling cases in the market that really cannot afford to seek protection any longer and there’s something wrong with that system.

Generally, I think the debtor picks his or her counsel. If he or she can't afford counsel, then Chapter 11 is no longer an option, but assuming the potential debtor is able to retain counsel, that’s not the end of it. The cost of committee counsel, what I have found in recent years, is greater than the cost of debtor counsel. The reason for that is big firms, and I don't mean this in a negative way, but big firms have a style of practice and that style is not necessarily the most conducive to the middle market and smaller cases. Notwithstanding, those firms have been winning committee cases. We've heard from the landlords before and I'm not going to join in the landlord bashing because I also represent landlords, but we see that landlord counsel comes in very often and because there are R.E.I.T.s, they represent bigger players and they still think bigger picture than a small case can afford.

They do get retained and suddenly, they’re working the case and I’m not saying the issues aren't important, the judge would be letting them know but notwithstanding what doesn't take place before the judge, what takes place out in the hall in that negotiation often hurts a case and kills a case. That has been our experience with a number of middle market cases where excellent firms but firms that didn't necessarily belong in that marketplace have come in asking for carve outs from a secured lender who says, "You know, that's just not going to make it. This case can't afford it. Maybe we're better off liquidating."

Yes, lenders are very happy to utilize the bankruptcy courts to get their assets sold but then again, when they find out what the cost is really going to be, the carve out that they’re being asked, what they are going to be left with at the end of the day, they’re saying, "Maybe you're right. Maybe I should take my collateral and sell it under Article 9 or some other way.”

I don't know what the answer is. I'm not here to address specific issues within the Bankruptcy Code, conflicts from one jurisdiction to another, but just to deal with a very basic problem, how do we make the process affordable? It's not affordable as it is today. You can ask any judge sitting in this district or the neighboring districts, they just don't see middle market cases like they used to.

Thank you for your time.

Togut:

Okay. I have a question on intellectual property. Do you two think that there should be a bright line test that the statute should set out: these are the things that have to happen, these are the circumstances that will allow for the assumption or not assumption, or do you favor -- a lot of people have advocated to us that there should be more judicial discretion to adapt to all the different possibilities that there could be?

Eisenbach:I actually think some of these issues, at least if we're talking about the assumption of a license, I think it's a fix that probably requires statutory language to make it clear that the debtor will be able to do that notwithstanding the hypothetical test and I know Ms. Fenning had specific comments about there may need to be some bounds on that. Possibly but I think fundamentally, we may want to protect against a change of control that is going on but I don't think we want to take away a debtor’s ability, when it really is the same debtor, to retain its intellectual property licenses.

I think leaving that in some way up to the discretion of the court to allow or not to would create the level of uncertainty that would start driving parties well before bankruptcy into strange machinations like the ones I was talking about. I think there’s an argument that foreign patent are indeed covered by 101(35A) by the way the language is structured but there’s a question mark and there’s uncertainty around it. People do things when there’s uncertainty that isn't necessarily helpful to a debtor or a future debtor or necessarily to the non-debtor party either.

Togut:

Judge Fenning?

Fenning:I'll preface with, I didn't I realize was Exhibit A to Mr. Wurst's first point, as a judge who left to pay college tuition. Different district.

For the most part, I don't think the kinds of issues that we're dealing with here are sliding scale issues. They are switch on switch off issues and the parties both outside of bankruptcy and in bankruptcy can conform their behavior a lot better if they understand what the rules and expectations are.

The only area where you could get into sliding scale discretion issues would be on what are adequate assurances for performance under a trademark license or those sorts of things that are inherently discretionary, but that is not the kind of a problem that either of us have attempted to address in our language.

The definition issues: Is a trademark in or out? Foreign patents, other attributes of patents, those are definitional problems and I don't think they really call for judicial discretion. This is an area where some certainty would be helpful and I don't think the judges would experience it as a withdrawal of any discretion that they believe they have now.

Keach:

Yes. Let me just follow up Judge Fenning, in particular on something you said because I want to make sure I'm clear about it. You appropriately said that debtors should not have greater rights with respect to their licenses and rights under bankruptcy than they have outside and you can probably agree that the same can be true of counterparties as well. Until I listened to the testimony today, I was of the opinion and I will admit, I'm in an actual test jurisdiction most of the time in the First Circuit so it's not a problem I have as a practical matter, but I was of the opinion there wasn't much of a brief for Catapult in any respect.

Just so that I understand your testimony, when you talk about change of control provisions being enforceable or other restrictions being enforceable, I assume you're talking about provisions that are already in the license so that they would be covered by the requirement that's generally applicable to assumption of contract that, number one, you have to assume the entire contract. You can’t cherry pick.

Number two, you still have to prove you can perform, so that if there were a change of control provision to the contract not financially related in any way, triggered by an ipso facto provisions, the debtor would nonetheless have to prove the assumption would not immediately lead it to breach, correct? Where are you going with that exactly?

Fenning:Let's take an example of a trademark license or a copyright license situation. Let’s take the example of the Disney Stores case that I mentioned. It matters a great deal for a company like Disney to have control over an entity that is operating stores under the Disney name. It required that if there were to be a wind down that certain provisions would take place and so forth, it would not be amenable nor should it be required to accept some substitute entity to perform where the substance of that entity differs radically from the debtor and they may hate the debtor by the time they get to the bankruptcy court but they should have control over that. Indeed, that license has all sorts of restrictions and control.

If you have a licensor who does not put any restrictions on change of control, assignment or anything like that in their license, first of all I'd be surprised, but if I didn't have anything in there, then there should be no reason under the kind of amendment that I would have in mind that the debtor should be able to assume or assign, if there’s no restrictions on it.

The issue is, at the moment, you'd have to allow for transition period if people didn't build those in because they’re assuming that non-bankruptcy law provides those protections in a bankruptcy context in light of applicable patent law with respect to assignment. With respect to assumption, it depends on whether they’re in a hypothetical or actual test jurisdiction.

Keach:

But again, just to be clear, we're talking about provisions that'll be in the license as of a petition date. We're not talking about new rights.

Fenning:Correct.

Keach:

If we take that assumption, then this'll go the point that Rich and I were quietly disagreeing about, at what point does the change of control provision become an ipso facto provision? In other words, what aspect of a change of control provision would be unacceptable because they would just become ipso facto provisions triggered by bankruptcy and by nothing else?

Levin:

Doesn't every reorganization, including an internal reorganization, result in a change of control? The creditors become the shareholders.

Fenning:Not everyone.

Levin:

Well, most. Many.

Fenning:I agree most, not everyone.

Levin:

But most.

Fenning:But most. I think it would be possible to fashion a test if the prepetition creditors became the equity owners post-petition, that is not a change of control.

Levin:

We can do it like 382 of the Internal Revenue Code, right?

Fenning:I'm not sufficiently familiar with