FEATURE STORY: Why don’t big Chicago companies use the bankruptcy court here?

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Out of seven companies with headquarters in Chicago that filed for bankruptcy protection in 2009, six of them, including Merisant Worldwide Inc., Sun-Times Media Group Inc., General Growth Properties Inc. and Tribune Co., filed elsewhere, seeking to gain an advantage that favors the company.

Companies may choose to file for bankruptcy protection where they are headquartered, where they are incorporated or where they have operations.  According to experts, this permits what lawyers call “forum shopping,” the practice of choosing a court believed to be more hospitable to your case.

“The companies won’t admit it, but it is forum shopping,” declared Sumner Bourne, chair of the Commercial Banking and Bankruptcy Section of the Illinois State Bar Association. “It’s not a stretch to say Delaware is more corporate friendly.” Three of the four Chicago companies filed there.

“I think it’s clearly forum shopping,” agreed Ronald Barliant, chair of the Bankruptcy and Reorganization Committee of the Chicago Bar Association. “They are taking advantage of the provisions in the law that allow filings other than where the business is. “They’re definitely choosing between alternative forums.”

The practice flies in the face of the “fine professional reputations of the judges of the Chicago court, which serves the Northern District of Illinois, and of the sizable contingent of experienced bankruptcy lawyers here.” Barliant said, “I’ve practiced all over the country. Chicago bankruptcy bar is the best in the country.”

On a mid-sized case, Barliant added, “a Chicago company filing outside Chicago adds hundreds of thousands of dollars to each case.”

So why do big companies here perceive an advantage in going to Delaware or New York, where General Growth filed?

Bankruptcy experts attribute the trend to a federal appeals court decision after the big Kmart Co. bankruptcy case here in 2002.

A Chicago bankruptcy judge allowed the big retail chain, in settling with its creditors, to give payment priority to critical vendors, certain suppliers deemed vital to the company’s future but considered unwilling to do business with a customer that hadn’t been paying its bills.

Capital Factors Inc., a Kmart unsecured creditor that was not deemed critical, appealed this decision.  In 2004, a three-judge panel of the Seventh Circuit Court of Appeals, housed in the same Dirksen Federal Building as the Bankruptcy Court, ruled that there was insufficient proof that it was necessary to prefer the critical vendors, and therefore Kmart should not have been permitted to do so.

Kmart was required to recover payments already made to critical vendors in order to pay all unsecured creditors more equitably, in accordance with the appellate court ruling, which does not apply beyond the four-state Seventh Circuit.

Lawyers say the ruling doesn’t mean that critical vendors cannot be preferred in the Chicago Bankruptcy Court. Barliant declared, anyone that looks at the issues and understands that issue knows it’s still possible to pay critical vendors. It’s just a question of doing it the proper way.

However, Barliant explained, “some debtors avoid the district [Northern District of Illinois] because of a misunderstanding of this. For others it’s an advantage because they have an excuse not to pay their critical vendors.”

Barliant argues that the single most important factor in this forum shopping is whether the interpretation of federal bankruptcy law in the filing state is favorable to what the company wants to do in the case.

Critical vendor law is an example of how two courts interpret the law differently, said Bourne.

“Though companies still may favor critical vendors in the Northern District of Illinois, the type of evidence [required here] is not something you can do quickly,” Bourne went on.  But in Delaware, he said, “there’s a lot of discretion for the debtor. The debtor doesn’t have to come up with much reasoning at all.”

Lynn M. LoPucki, a bankruptcy expert currently teaching at Harvard Law School, believes the bankruptcy courts have been corrupted by competition for big cases.

He said in an interview, “the Chicago judges initially thought they could compete, but competition requires a willingness to ignore the law and put a thumb on the scale for the lawyers, managers and DIP [Debtor in Possession] lenders who bring cases to the court.  I think that after Kmart, the Chicago judges simply realized that they were not willing to do what it took to compete.”

Since 2004, 11 out of 13 big Chicago-based companies headquartered in Chicago that filed for bankruptcy protection chose New York or Delaware. The two that filed in Chicago were the smallest of the lot, with fewer employees and lower revenues.

In May, LoPucki told the House Judiciary Committee that the Delaware and New York bankruptcy courts must be doing something to attract 70 percent of all bankruptcy cases filed under Chapter 11, which provides for corporate reorganization, usually meaning reduction of debt enabling the company to continue operating.

The result, he testified, is that Chapter 11 is evolving a bias, a bias that is in favor of the people who control the choice of the court: the managers of the company, the professionals who represent the company, and whoever finances the bankruptcy. But every bias in favor of someone is a bias against someone else. And the people on the other side of this bias are the creditors, the suppliers, the employees, the landlords, the tax authorities, the dealers, the communities, literally hundreds of thousands of people. It is not a level playing field for the rest, LoPucki averred.

Chicago companies provided watery responses when asked why they filed outside the Northern District of Illinois.

Gary Weitman, senior vice president of corporate relations of Tribune Co. said, “This wasn’t a difficult decision and involved no deliberation. Tribune Company is incorporated in Delaware, hence any filing has to be done there.” In fact, that’s not a requirement of bankruptcy law. Kmart was not incorporated in Illinois.

Tammy Chase, director of corporate communications for Sun-Times Media Holdings LLC, said of the company’s Delaware filing, “Judges are experienced, the courts are experienced.  You know you’re going to get a judge that knows that law.” Chase expects the process will be smooth and expeditious in Delaware.

Merisant spokeswoman Katie Wood said, “The debtors in possession [companies in bankruptcy] are all based in Delaware. The judges are specialists in this area.”

Jim Graham, a spokesman for General Growth Properties, said, “Most companies that file bankruptcy have a number of choices for where they can file bankruptcy. In making a determination, many factors are considered, including but not limited to, the business of the company, the legal issues that need to be addressed in the bankruptcy, the existing bankruptcy law in the various jurisdictions, the expertise of the judges in the various courts, and the location of the parties involved. These factors, and others, lead companies to choose Delaware, New York and other jurisdictions for filing.  He did not specify which factors led General Growth Properties to file in New York.

I’m sure the debtor would give a canned response,” commented Bourne of the Illinois State Bar Association, “because they don’t want to make it look like they’re forum shopping. At the same time,” he acknowledged, “they can make a choice.”

Many companies incorporate in Delaware because its law is known for being corporation-friendly and it has a well-respected court system experienced in handling business disputes.

To Kenneth Ayotte, associate professor of law at Northwestern University, the bankruptcy-filing trend is “most likely a case of forum shopping for expertise. A minor screwup can kill off the firm.

However, he added, Chicago has dealt with these cases. I’m not really sure why it’s happening now.

The big global, theoretical problem with it is that it distorts the legal system, said Barliant. “In every other area of law we require cases be decided in the location where they have some connection other than just the filing of articles of incorporation. It’s inconsistent with all other areas other than patent cases. Even in patent cases any district court can hear them.  We just don’t do this with any other area of American law.