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Congress May Break Corporate Bankruptcy

US Capitol Building with cash
US Capitol Building with cash

Late last week, lawmakers on a House Judiciary subcommittee held a hearing focused on banning the practice of bankruptcy protection "forum shopping."

For the uninitiated, some powerful special interests and lawmakers regard it as an unfortunate "loophole" that companies can file for bankruptcy protection where they are incorporated, or even in places where they do a small amount of business. They would prefer companies be forced to file where most of their assets are located, or where their headquarters are located.

Borders' bankruptcy filing is a commonly cited example. The bookseller is based in Ann Arbor, Mich., but it has stores all over the country. The company filed for bankruptcy protection in federal court in New York, where it had a relatively small number of stores.

Both New York and Delaware, where something like 40 percent of U.S. business are incorporated, get almost all of the big bankruptcy cases.

Both courts have a lot of experience and expertise in handling large, complex bankruptcies. But some argue that the real reason these courts are favored is because they sell short the interests of smaller "stakeholders," including small creditors, retirees, and employees.

So at the House Judiciary subcommittee panel last Thursday, lawmakers brought in a host of experts to tell them that breaking this system would be a good idea.

One of the voices of dissent on this issue in my namesake, Congressman John Carney (D.-Del.). Obviously, he's got an interest in protecting his home team courts—but he's right on this.

“From a business perspective, companies are choosing the court that they want to use to get restructured and running again,” Carney said, according to The Wall Street Journal. Unfortunately, Carney's not a member of the subcommittee, so he did not have the right to speak at the meeting.

Ironically, the changes contemplated by the reformers would probably backfire. Changing the bankruptcy rules would make the cost of funding and doing business for companies based outside of New York or Delaware more expensive. Bond buyers and customers would be exposed to new types of risk: Unpredictable courts and the inability to predict where a bankruptcy filing might take place. For instance, substantial expansion by a company in, say, California, might suddenly subject a company to having to file for bankruptcy protection there. Bond buyers would find their exposure to bankruptcy shifting as businesses expanded into new areas.

It would likely constrain business growth in areas with courts regarded as less experienced. Some companies, to avoid higher funding costs and business risks, would relocate to Manhattan or Delaware. The unintended consequence of the change could be less growth and lost businesses for the very jurisdictions the law would seek to give power to.

Lawmakers seem displeased that Delaware and New York have won the jurisdictional competition for bankruptcies, so they are seeking to restructure the market to undo this process. But the market, they'll discover, doesn't have to take this lying down. And it won't.

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