THE TOOLBOX: Venue Selection and Forum Shopping in Large Chapter 11 Cases

The topic this month is venue. Though there are venue options in consumer bankruptcy cases—domicile, residence, principal place of business and location of principal assets are established as proper venues under 28 U.S.C. § 1408(1) for individuals as well as businesses—section 1408(2) creates a legion of venue options for a large, multi-entity enterprise. Section 1408(2) allows entities to piggy-back on the venue of an affiliate. ¹An individual may have an affiliate to determine venue as well, but that is much rarer. See section 101(2) of the Bankruptcy Code, which defines “affiliate.” For example, Eastern Airlines and LTV Corp.—respectively headquartered in Georgia and Texas—used New York based affiliates (Ionosphere Clubs and Chateaugay Corp. respectively) to predicate venue in the Southern District of New York.

Moreover, pursuant to Federal Rule of Bankruptcy Procedure 1014(b), once a venue is established by a first-filing affiliate, the court in which that entity’s case is pending can transfer cases of its affiliates to it. Further, even when a case is filed in the wrong district, it may be retained there unless the court determines transfer of the case “is in the interest of justice or for the convenience of the parties.” Rule 1014(a)(2). ²This language is repeated in 28 U.S.C. §§1404(a) and 1412 as well as section 32 of the former Bankruptcy Act.

Thus, the question of whether a case should proceed in a different venue is firmly fixed in the first court selected for a filing, ³An involuntary case also serves to establish the first court for purposes of Rule 1014. even if it is not a proper venue. In a large Chapter 11 case, this often means that, as a practical matter, a motion to change venue is a waste of time, at least if its consideration is delayed beyond the first weeks of the case. Courts often consider a set of bankruptcy-specific factors in deciding a motion to transfer venue under 28 U.S.C. §1412, which provides that the court may transfer venue in a bankruptcy case in the interest of justice or for the convenience of the parties. In the Fifth Circuit, and in courts in other circuits, courts usually look to factors considered by the Court of Appeals in the seminal decision of Puerto Rico v. Commonwealth Oil Ref. Co. (In re Commonwealth Oil Ref. Co.), 596 F.2d 1239, 1247 (5th Cir. 1979), ⁴Commonwealth Oil was decided under section 32 of the former Bankruptcy Act, which was similar in most (but not all) respects to present sections 1408 and 1412 of title 28. when deciding whether to keep a case when venue is appropriate in more than one jurisdiction under §1408. See In re Reichmann Petrol. Corp., 364 B.R. 917, 922 (Bankr. E.D. Tex. 2007). The factors considered in Commonwealth Oil are as follows: (1) the proximity of creditors to the court; (2) the proximity of the debtor to the court; (3) the proximity of the witnesses necessary to the administration of the estate; (4) the location of the assets; (5) the economic administration of the estate; and (6) whether ancillary administration will be necessary. Commonwealth Oil, 596 F.2d at 1247.

It is not unusual for a bankruptcy court to see the most important of these as being the progress made before it in the case, which is implicated by the economic administration of the estate. As it is likely that, among other things, early in the case committees will be established, professionals hired, financing put in place, prepetition wages paid, corporate retention programs approved, notice procedures established and utilities satisfied under the supervision of the court, it is easy for a judge to reject a transfer motion based on how much has happened already in the case. Given that judges and practitioners are often anxious to retain locally high-profile cases, it is unsurprising that venue transfer motions are rarely granted in large cases.

The effect of a wide range of venue options is licensed forum shopping. The practitioner representing a prospective Chapter 11 debtor enterprise will be able to pick any venue in which one of the affiliated debtors could properly be venued—or, in many cases, he may choose the District of Delaware based on a debtor’s state of incorporation—its domicile. An entire service industry in Chapter 11 has sprouted in the last quarter century in Delaware due to the tendency to organize public or other large corporations under Delaware law.

Forum shopping is a bit like some drugs ⁵Indeed, even attempts to manufacture venue have been seen in the courts. See In re Reichmann Petrol. Corp., 364 B.R. at 922. The temptation to do so, including by creation of a subsidiary located in the desired jurisdiction, in my experience is generally resisted—a mark of the high ethical standards of most bankruptcy lawyers.—say cortisone. It can be very helpful in some cases, but it is best avoided most of the time. It may be reasonable, if a large enterprise’s headquarters is located in a rural area that is difficult of access, to choose an alternative venue that the parties will find more convenient for travel and temporary residence. Likewise, a venue with more available judicial resources may be a good choice: if an alternative venue is overloaded with business or the court sits there only on circuit, efficient administration may be served by choosing a different place for filing.

Another reason to choose a given venue that makes good sense is if one venue offers a greater chance of a successful reorganization other than an alternative. Factors such as binding precedent on a given issue enter into this analysis as does the recovery seen by creditors in other Chapter 11 cases. The rare large case where equity interests also receive consideration for their investments should count in this analysis as well. Whether a venue is available where the judge in similar cases has overseen stellar results should be the first question addressed in deciding where to file a case. In that regard, simply confirming plans may not be a fair indication of a court’s—or judge’s—contributions to success or efficiency. Plans result and are confirmed even in cases that pay little or nothing on unsecured claims.

Venue selection may also reasonably be based in part on applicable law. For example, the Courts of Appeal for the Third and Fifth Circuits use different constructions of Bankruptcy Code section 365(e). Compare In re Mirant Corp., 440 F.3d 238 (5th Cir. 2006) (adopting the “actual test” to determine, on a case-by-case basis, whether a law is applicable to a given set of facts such that it merits an exception to section 365(a) of the Code), with Cinicola v. Scharffenberger, 248 F.3d 110 (3rd Cir. 2001) (supporting the proposition that a “hypothetical test” is required to determine whether an applicable law generally allows an exception to section 365(a)). If interpretation of a given section of the Bankruptcy Code (or other law critical to the case) is likely to be a key issue in a case, and alternative available venues allow a debtor to take advantage of favorable precedent, it is often appropriate to select a venue accordingly.

Similarly a given bankruptcy court may have rendered decisions that give a comfort on issues important to keeping a debtor’s business alive. For example, in an unpublished decision, In re Tusa-Expo Holdings, Inc., 2008 BL 253026, at *8 (Bankr. N.D. Tex. Nov. 7, 2008), I opined that a failure to grant a motion to pay prepetition priority wages would, absent unusual facts, be an abuse of my discretion. This, like local rulings, in my and other courts, may give counsel and its client comfort that operations of the debtor will continue post-petition. The rulings of a given court on financing, utilities, and Federal Rule of Bankruptcy Procedure 6003 may affect a debtor’s decision as to which courts will typically provide the relief necessary to keep the debtor viable.

However, as focus turns to bankruptcy courts, the venue rules are often bent for purposes other than to foster efficient and economic estate administration. It is perhaps reasonable for professionals to prefer a forum convenient to them, and it may even be okay for counsel to promote a venue where the firm’s employment and payment will be more certain. However, if those are the reasons a lawyer encourages a filing in a given district, the client debtor should clearly understand them and understand how they are or are not balanced by the benefits available elsewhere as well as any downside to picking the lawyer’s choice of venue.

A recent article in the American Bar Association Journal ⁶Playing on Home Court: New York and Delaware May Lose their Grip on Bankruptcy Cases, A.B.A. J., Mar. 2012, at 16-17. suggests that venue decisions are often made on the basis that the court in the district with closest connections to the debtor is inexperienced in large cases or not predictable as to its results. ⁷It is also suggested that lenders play a role in picking a debtor’s venue. While a lender is often the most important creditor in a debtor’s reorganization, it is debatable whether allowing that creditor to dictate where a debtor files its Chapter 11 case is sensible. No data I have seen suggests that lenders, miffed over rejection of their choice of venue, will refuse to finance debtors in Chapter 11. It is certainly true that a judge of a court in which many large Chapter 11 cases are filed will, over time, gain greater experience in handling large cases than a judge sitting in a venue where fewer cases of that sort are filed. Indeed, the prediction that the judges of one court will be more experienced than those of another becomes a self-fulfilling prophecy as large cases are concentrated in a small number of venues.

But experience does not lead inexorably to success. Moreover, at least in any large urban area (and in most rural areas), the bankruptcy judges will have considerable experience both from presiding over Chapter 11 cases and from private practice. The truth is that the level of experience depends on the individual judge and the number of large cases a judge has had is less indicative of the outcome of a Chapter 11 case than the success of each debtor’s reorganization.

As to predictability, properly viewed this means consistency in a judge: that the judge, given similar facts, will rule the same way. Unfortunately, some lawyers believe a judge is not predictable unless he or she will rule as would a judge in the district that the lawyers favor. While it may indeed save time and money to be able to use the same forms and follow a cookie-cutter approach in administrative matters that arise in most cases, the savings is relatively small in a large Chapter 11 case and may not even compare to travel and other costs incurred in filing in counsel’s comfortable, familiar venue district. In fact, most judges strive for consistency in its true sense, and that consistency is no less recognizable in one court than another.

There are some who believe there are attorneys who use assurances of experience and predictability of judges in certain districts as cover for the real reasons venue is preferred by them over another—the convenience and best interests of the debtor’s professionals. Rather than focusing on results achieved on a court-to-court basis, such counsel presumably elect benefit for themselves over the good of the client and that of the constituencies which the client serves. If that is the case, the lawyer places his or her firm and management of the firm’s client at considerable risk for small reward. I personally doubt that most attorneys act this way—though some may fear appearing in an unfamiliar jurisdiction enough to work hard to avoid it.

From the practitioner’s perspective ethical obligations should be enough to assure that possible venues are evaluated on bases consistent with the client’s needs. But there is another reason why any attorney who would drag cases into a court that is not most suitable should be having second thoughts about that practice. Congress currently has before it a bill that would change the venue rules for large Chapter 11 cases. H.R. 2533, 112th Cong. (2011). While the bill is not likely to pass, both because of the present problems Congress has enacting any legislation and because the bill as written would result in the possible piece-mealing among various courts of related debtors engaged in a single enterprise, the bill is indicative of increasing frustration with the use of the present law to concentrate large cases almost exclusively in the Southern District of New York and the District of Delaware (23 BBLR 1083, 9/15/11).

By stretching the venue rules—especially through the piggy-backing allowed by section 1408(2)—proponents of those venues risk Congress ultimately changing the venue rules to make those courts infrequently available. Under H.R. 2533, Congress would hope to see cases filed in the districts in which the communities most concerned about the debtor are located—the district of the debtor’s headquarters.

Hopefully H.R. 2533 is warning enough that venue rules may be changing, and not necessarily for the better. If counsel addresses venue issues based on both community interests (what are the Los Angeles Dodgers doing in Wilmington?) and successful, efficient and economic restructuring, it would be less likely that Congress would change the rules. In using the “venue tool” to achieve a client’s ends, not only may the rate of successful reorganizations be increased, but also to the demise of currently favored venues as assured places of filings may be avoided.