American Bar Association Business Law Section Business Bankruptcy Committee. February 17, 2010 (Updated April 20, 2010) LEGISLATIVE UPDATE

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1 American Bar Association Business Law Section Business Bankruptcy Committee February 17, 2010 (Updated April 20, 2010) LEGISLATIVE UPDATE Judith Greenstone Miller Chair, Legislation Subcommittee Lisa P. Sumner Vice Chair, Legislation Subcommittee Red Flag Rules: On August 27, 2009, the ABA filed a lawsuit in the U.S. District Court for the District of Columbia challenging the FTC s Red Flag rules that require a broadly defined category of creditors to implement identity theft prevention programs by November 1 st. 1 The lawsuit, American Bar Association v. Federal Trade Commission, Case No (RBW), seeks to prohibit the FTC from applying the rules to practicing attorneys. The complaint states that the application of the rule to practicing attorneys is arbitrary, capricious, and contrary to law and imposes a serious burden on law firms. In addition, the ABA contends in the complaint that the FTC has failed to articulate a rational connection between the practice of law and identity theft; an explanation of how the manner in which lawyers bill their clients can be considered an extension of credit under the Fair and Accurate Credit Transactions Act; any legally supportable basis for application of the red flags rules to lawyers engaged in the practice of law. The FTC contended that lawyers should be covered because many of their billing practices, such as charging clients on a monthly basis rather than in advance, make lawyers creditors that fall within the ambit of the rules. On October 29, 2009, Judge Reggie Walton for the United States District Court for the District of Washington, D.C. held in a bench ruling that the FTC cannot force practicing lawyers to comply with the Red Flag Rules. In ruling upon the issues, Judge Walton indicated that he had trouble with the FTC s definition of creditor. According to the judge, under the FTC s interpretation, a plumber who charges a customer after working on a toilet for two days would also be considered a creditor. The judge also indicated that he did not think that Congress had intended to regulate lawyers when these statutes were enacted. It is anticipated that the FTC will appeal the ruling. On February 25, 2010, the FTC filed a notice of appeal to the D.C. Circuit appealing the decision of Judge Walton. John Daly, deputy general counsel for litigation at the FTC, is representing the agency in the appeal. 1 This date for implementation has already been postponed three times.

2 After the ruling, on October 30, 2009, the FTC, citing to a request from the House, announced that it was delaying enforcement of the Red Flag Rules for a 4 th time until June 1, According to the FTC, the extension will provide Congress with more time to address industry group concerns related to the FTC broad interpretation of the rules. On October 8, 2009, Representative John Adler (D-NJ) introduced HR 3763 that would exempt certain businesses from the FTC s Red Flag rules. Under the Bill, health care, accounting and legal practices with 20 or fewer employees would not be included as creditors. In addition, the Bill would require the FTC to issue rules allowing any business to apply for an exemption form the rule. The House Financial Services Committee plans to mark up the legislation. The House approved the Bill on October 20, 2009 by a vote of 400 to 0. April 20, 2010 Update: In October, 2009, Senate referred Bill to Committee on Banking, Housing and Urban Affairs. No significant action reported since that time. Milavetz, Gallop & Milavetz v. United States: The ABA has filed an amicus brief in this case pending in the United States Supreme Court that was appealed from a decision in the Eighth Circuit Court of Appeals. The issue before the Court is whether lawyers are debt relief agents under the Bankruptcy Abuse Prevention and Consumer Protection Act ( BAPCPA ). The Eighth Circuit Court of Appeals held that attorneys who provide bankruptcy assistance to assisted persons are debt relief agencies as that terms is defined by the Code. Milavetz, Gallop & Milavetz, P.A. v. United States, 541 F.3d 785, 792 (8 th Cir. 2008). The ABA has argued that if this provision of BAPCPA that require debt relief agencies to make various disclosures applied to attorneys it would have a substantial negative impact on the regulation of the legal profession by the state judicial systems. In addition, its application to attorneys would significantly and unnecessarily undermine and create new exceptions to the attorney-client privilege and would be contrary to the goals of encouraging full and frank communication and protection of the client s interests. The hearing before the United States Supreme Court on this case took place on December 1, A copy of the amicus brief submitted by the ABA can be found at this link: A copy of the transcript from the Supreme Court argument can be found at this link: On March 8, 2010, the United States Supreme Court issued its opinion in this case holding that (i) attorneys are debt relief agencies under BAPCPA, and (ii) the prohibition to incur debt in contemplation of bankruptcy is constitutional. A copy of the decision from the Supreme Court can be found at this link: The Medical Bankruptcy Fairness Act of 2009 (S.1624): Senator Whitehouse (D-RI) introduced a Bill to amend title 11 to provide protection for medical debt homeowners, to restore bankruptcy protections to individuals experiencing economic distress are caregivers to the ill, injured or disabled family members and to exempt means testing 2

3 debtors whose financial problems were caused by serious medical problems. The Bill was referred to the Judiciary Committee. Hearings were held on the Bill by the Senate Judiciary Committee s Subcommittee on Administrative Oversight and the Courts on October 20, The witnesses that testified at the hearing included John A.E. Pot Tow, a professor of law at the University of Michigan, Parana Mathura, a research fellow at the American Enterprise Institute for Public Policy Research in Washington, and Diana Furchtgott-Roth, senior fellow at the Judson Institute in Washington. April 20, 2010 Update: No significant action reported since October, According to Senator Whitehouse, medical bills are responsible for at least 60% of the bankruptcy filings. The proposed legislation would modify the means test to provide that a medical debt is any debt incurred directly or indirectly as a result of the diagnosis, cure, mitigation, treatment, or prevention of injury, deformity, or disease, or for the purpose of affecting any structure or function of the body. The Bill also defines medically distressed debtor as a debtor who, in any consecutive 12-month period during the three years before the petition filing date incurred or paid medical debts for the debtor, a dependent, or a nondependent member of the immediate family of the debtor, not paid by any third-party payor and in excess of the lesser of $10,000, or 10% of the debtor s adjusted gross income. Highlights of the Bill are: Would outline circumstances under which a medically distressed debtor can claim an exemption of up to $250,000 of the debtor's aggregate interest in specified real or personal property that the debtor (or dependent) uses as a residence, in a cooperative, or in a burial plot for the debtor (or dependent). Would prohibit the court or specified parties from filing a motion to dismiss or convert to Chapter 11 or 13 if the debtor is a medically distressed debtor. Would waive the credit counseling requirement for a medically distressed debtor. Would deny a discharge of debt incurred for attorneys' fees to file a Chapter 7 debtor s petition. Would require written, sworn certification by a debtor claiming medically distressed status that the medical debts were not incurred specifically to bring the debtor within the coverage of these special provisions. 3

4 Too Big to Fail The Role for Bankruptcy and Antitrust Law in Financial Regulation Reform: - Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173), Too Big to Fail, Too Big to Exist Act (S and H.R. 4142) and Financial Services Industry Stability Act of 2010 (H.R. 4516): The Too Big to Fail Bills consist of four separate Bills, three introduced in the House and one introduced in the Senate, each of which is described below. H.R. 4173: On October 22, 2009, the House Judiciary Subcommittee on Commercial and Administrative Law held a hearing on the role of bankruptcy and antitrust law in the area of the financial regulatory system in response to the Obama Administration s proposal that the largest financial institutions be restructured by the federal agencies rather than through the bankruptcy system. Testifying at the hearing was Treasury Assistant Secretary Michael S. Barr who indicated that the proposal is narrowly limited to situations in which there are exceptional threats to financial stability. It is not intended to replace bankruptcy. This original Bill was passed by the House on 12/11/2009 and thereafter was received in the Senate, read twice and referred to the Committee on Banking, Housing, and Urban Affairs. April 20, 2010 Update: No significant action reported since January, 2010 when referred to Senate Committee. The Bill is opposed by the American Bankers Association, the National Association of Federal Credit Unions, the U.S. Chamber of Commerce and the Mortgage Bankers Association This Bill is extensive and the subject of over 20 proposed amendments in the House. Highlights of this original Bill include: Would establish a Financial Services Oversight Council, consisting of the heads of specified federal financial regulatory bodies and chaired by the Secretary of the Treasury, to: (1) resolve a dispute among two or more federal financial regulatory agencies in specified circumstances; (2) subject a financial company to stricter prudential standards; and (3) require a financial holding company to undertake one or more mitigatory actions to address any grave threat its activities pose to the financial stability or economy of the United States. Would give the Federal Reserve Board and the Council power to impose stricter standards on financial holding companies and certain financial activities or practices to promote financial stability. Would amend the Securities Act of 1933 to direct the appropriate federal financial regulatory agencies to prescribe regulations to require any creditor to retain an economic interest in a material portion of the credit risk of any loan the creditor transfers, sells, or conveys to a third party, including for the purpose of including such loan in a pool of loans backing an issuance of asset-backed securities. Would allow appointment of the FDIC as receiver for one year to resolve, liquidate, or take other specified emergency stabilization actions with respect to a financial 4

5 company whose imminent or actual default would have serious adverse effects on financial stability or economic conditions in the United States. Would authorize the Federal Reserve Board to terminate the activities of the U.S. branch, agency, or subsidiary of a foreign bank that presents a systemic risk to the United States. Would amend the Securities Exchange Act of 1934 to require a separate, non-binding shareholder vote to approve the compensation, including golden parachute compensation, of corporate and financial institution executives. Would repeal the exemption from CFTC regulation of derivatives transaction execution facilities and boards of trade, and create extensive regulation of and restrictions on swap markets. Would create a Consumer Financial Protection Agency (CFPA) as an independent agency to regulate the provision of consumer financial products or services. Would impose new examination requirements for small insured depository institutions (with total assets of $10 billion or less) and credit unions (with total assets of $1.5 billion or less). Would require the CFPA Director to lead a Negotiated Rulemaking Committee to promulgate appraisal independence requirements for residential loan purposes. Would require the CFPA Director to conduct an annual financial autopsy regarding bankruptcies and foreclosures, including any specific financial products or services that have caused substantial numbers of them. Would allow the FDIC to commence an involuntary bankruptcy case against a depository institution holding company or other company participating in a guarantee program established by the FDIC on the ground that the company has defaulted on a debt or obligation guaranteed by the FDIC. Would give any FDIC receivership for a covered financial company supremacy over any proceeding against the financial company under State insolvency law and over any bankruptcy case under title 11. Would allow the FDIC to convert a receivership to a chapter 7 bankruptcy case and allow the FDIC to serve as the trustee for the company. S and H.R. 4142: S.2746 was introduced on 11/05/2009 and referred to the Banking, Housing and Urban Affairs Committee. April 20, 2010 Update: No further action reported. H.R was introduced on 11/19/2009 and referred to the Financial Services Committee. April 20, 2010 Update: No further action reported. 5

6 Both Bills would require the Treasury Secretary to send Congress a list of all commercial and investment banks, hedge funds and insurance companies that the Secretary believes are too big to fail, and then require the Secretary to break up such entities to protect the United States economy. Financial Services Industry Stability Act of 2010 (H.R. 4516): This Bill was introduced on 1/26/2010 and referred to the Financial Services Committee. April 20, 2010 Update: No further action reported. Key provisions of the Bill are: Would direct the Federal Reserve Board Chairperson, in consultation with other federal departments and agencies, to develop regulations to ensure no financial company can pose a systemic risk to the health of the United States economy by becoming too large to fail. The new regulations would provide for restructuring of financial companies that are deemed too large to reduce the size and scope of their operations, and may impose increased capital reserve requirements. Annual levies on financial companies would be used to create a fund for the purpose of financing restructurings of companies that are too large to fail. Employees' Pension Security Act of 2009 (H.R. 4281): The Bill was introduced on 12/10/2009 and referred to the House Education and Labor Subcommittee on Health, Employment, Labor, and Pensions on 1/4/2010. April 20, 2010 Update: On 3/1/10, referred to House Subcommittee on Commercial and Administrative Law. The Bill provides: Would amend Section 507 of the Bankruptcy Code to allow priority for unsecured benefit claims of participants and beneficiaries under a single-employer plan in connection with termination of the plan, to the extent such claims are in excess of the benefits payable to the participants and beneficiaries by the Pension Benefit Guaranty Corporation under section 4022 of the Employee Retirement Income Security Act of Personal Data Privacy and Security Act of 2009 (S. 1490): The Bill was introduced on 7/22/2009 and Sen. Leahy from Committee on Judiciary filed a written report on the Bill on 12/17/2009. April 20, 2010 Update: Minority and supplemental views were filed, but no other action reported. 6

7 The Bill provides: Would amend the Bankruptcy Code to prohibit dismissal or conversion of a bankruptcy case based upon a debtor's failure to meet means testing eligibility requirements if such debtor is a victim of identity theft. Bankruptcy Judgeships Act of 2010 (H.R. 4506): The Bill was introduced on 1/26/2010 and referred to the House Committee on the Judiciary. On 1/27/2010, it was ordered to be reported by voice vote. April 20, 2010 Update: Passed House on 3/12/10. On 3/15/10, referred to Senate Committee on the Judiciary. The Bill provides: Would increase by 13 the number of permanent offices of bankruptcy judges, convert 22 temporary bankruptcy judgeships to permanent offices and extend the duration of 2 temporary offices. Includes PAYGO (pay-as-you-go) offset provisions increasing bankruptcy filing and related fees in order to fund the additional positions and remain budget neutral. Specifically, filing fees for Chapter 7 and Chapter 13 cases by $1, and by $42 for Chapter 11 cases. April 20, 2010 Update: New bankruptcy-related bills since our last update: Protecting Employees and Retirees in Business Bankruptcies Act of 2010 (S and H.R. 4677): The Bill was introduced on February 24, 2010 and would revise numerous Bankruptcy Code provisions relevant to the claims of employees and retirees. The fairly long text is summarized by the Congressional Research Service as follows: The Bill would increase to $20,000: (1) allowed unsecured claims in the fourth order of priority (wages, salaries, or commissions); and (2) the factor multiplied by the number of employees covered with respect to employee benefit plan contributions in the fifth order of priority. Includes within the scope of a claim in bankruptcy certain equity securities held in a defined contribution plan for the benefit of certain individuals, but only if an employer or plan sponsor who has commenced a case in bankruptcy has committed fraud regarding the plan or has otherwise breached a duty to the participant that has proximately caused the loss of value. Allows as an administrative expense: (1) severance pay owed to certain employees of the debtor for layoff or termination (which pay shall be deemed earned in full); and (2) damages as a result of violation of law by the debtor. Includes among prerequisites for confirmation of a business reorganization bankruptcy plan (Chapter 11) provision for: (1) recovery of damages payable for the rejection of a collective bargaining agreement, or other financial returns as negotiated by the debtor and the authorized 7

8 representative; (2) continued payment of retiree benefits maintained or established by the debtor before the petition filing date if no modifications are made before confirmation of the plan; and (3) recovery of claims arising from the modification of retiree benefits or for certain financial returns, as negotiated by the debtor and the authorized representative. Revises requirements governing: (1) rejection of collective bargaining agreements; (2) payment of insurance benefits to retired employees, including benefit modifications proposed by the trustee; and (3) a trustee's administrative power to dispose of property. Requires the court, in approving a sale of business assets, to consider the extent to which a bidder has offered to maintain existing jobs, preserve terms and conditions of employment, and assume or match pension and retiree health benefit obligations in determining whether an offer constitutes the highest or best offer for such property. Requires the bankruptcy court to allow certain claims asserted by an active or retired participant, or by a labor organization representing such participant, for any shortfall in pension benefits accrued as a result of the termination of the plan and limitations upon the payment of certain statutory benefits. States that, if employees have not received wages and benefits for services rendered on and after the date of the commencement of the case in bankruptcy, such unpaid obligations shall be deemed necessary costs and expenses of preserving, or disposing of, property securing an allowed secured claim and shall be recovered even if the trustee has otherwise waived certain provisions under an agreement with the holder of the allowed secured claim. Allows reduction of a debtor's time frame for filing a Chapter 11 bankruptcy plan in the event of: (1) the filing of a motion seeking rejection of a collective bargaining agreement if a plan based upon an alternative proposal by the labor organization is reasonably likely to be confirmed within a reasonable time; or (2) the proposed filing of a plan by a proponent other than the debtor, which incorporates the terms of a settlement with a labor organization, if such plan is reasonably likely to be confirmed within a reasonable time. Modifies requirements for confirmation of a Chapter 11 bankruptcy plan to prohibit approval of: (1) payments or other distributions for the benefit of insiders, senior executive officers, and certain highly compensated employees or consultants providing services to the debtor, except as part of those generally applicable to the debtor's employees if the court determines that such payments are not excessive or disproportionate compared to distributions to the debtor's nonmanagement workforce; and (2) insider compensation unless approved by the court as reasonable according to specified criteria. Restricts: (1) certain executive compensation enhancements as part of the allowance of administrative expenses; (2) trustee assumption of certain deferred compensation arrangements for the benefit of insiders, senior executive officers, or certain highly compensated employees of the debtor; and (3) trustee assumption of retiree benefits for insiders, senior executive officers, or certain highly compensated employees of the debtor if the debtor has obtained relief to impose reductions in retiree benefits, or health benefits of active employees of the debtor, or has reduced 8

9 or eliminated health benefits for active or retired employees within 180 days before the date of the commencement of the case. Requires the court, where a debtor has obtained relief by which it reduces the cost of its obligations under a collective bargaining agreement or a retiree plan, fund, or program of retiree benefits, to determine before granting relief the percentage diminution in the value of the obligations when compared to the debtor's obligations under the collective bargaining agreement, or with respect to retiree benefits. Authorizes the trustee in bankruptcy to avoid a transfer made in anticipation of bankruptcy to or for the benefit of an insider, including certain consultants who were formerly insiders and who are retained to provide services to an entity that becomes a debtor. Grants a labor organization creditor status for purposes of filing a proof of claim. Declares that the filing of a petition for relief does not operate as an automatic stay of the commencement or continuation of a dispute resolution proceeding established by a collective bargaining agreement that was or could have been commenced against the debtor before the filing of a petition, including payment or enforcement of an award or settlement under such proceeding. Chapter 7 Bankruptcy Administration Improvement Act of 2010 (H.R. 4950): The Bill was introduced on 3/25/10 and referred to the House Committee on the Judiciary. A new subsection would be added to 11 U.S.C. 326(a) to increase the amount of compensation the court could award a chapter 7 trustee in the form of a commission based on distributions to parties, including secured creditors, as follows: (a) Up to 25% on the first $50,000 or less; (b) 15% on amounts over $50,000 but not over $250,000; (c) 5% on amounts over $250,000 but not over $1,000,000; and (d) 3% on amounts over $1,000,000. By comparison, the current Section 326(a) establishes the following trustee compensation scale: (a) Up to 25% on the first $5,000 or less; (b) 10% on amounts in excess of $5,000 but not in excess of $50,000; (c) 5% on amounts in excess of $50,000 but not in excess of $1,000,000; and (d) Up to 3% on amounts in excess of $1,000,000. 9

10 Fairness for Struggling Students Act of 2010 (S. 3219) and companion House Bill (H.R. 5043): Both Bills were introduced on April 15, 2010 and would revise 11 U.S.C. 523(a) to make privately issued student loans dischargeable to the same extent as any other private debt. Only government issued or guaranteed student loans would be protected from discharge, which was the case prior to amendments in A hearing is scheduled by the House Judiciary Committee on April 22,