Contributed by Kelly E. McDonald
For this month’s highly anticipated Weil Bankruptcy Blog Breaking the Code entry, the super-secret section generator that resides in an undisclosed location on the 27th floor of Weil’s New York office spat out section 1108 of the Bankruptcy Code. Although section 1108 is one of the shortest sections in the Bankruptcy Code at only 25 words, it is one of the few Bankruptcy Code provisions that is cited in nearly every paper filed by a debtor in possession in its chapter 11 case. Unless, of course, it is not because the power of the debtor in possession to operate the business has been restricted by order under section 1108, as described below.
The Effect of Section 1108
For those bankruptcy practitioners that have come of age in the last thirty years or so, section 1108 seems to state the obvious: “Unless a court, on request of a party in interest and after notice and a hearing, orders otherwise, the trustee may operate the debtor’s business.” Bankruptcy lawyers learn early in their studies that the difference between a chapter 7 filing and a chapter 11 filing is that the effect of a chapter 7 filing is the creation of the estate and the appointment of a trustee to marshal and liquidate the assets of the estate and pay creditors their pro rata share of the estate. On the other hand, when section 1108 is coupled with section 1107(a) of the Bankruptcy Code (which affords a debtor in possession nearly all the rights of a trustee), the initial effect of a chapter 11 case filing is that the debtor in possession continues to operate the business of the debtor.
Section 1108 Furthers Reorganization Goals of Chapter 11
Section 1108 is the key provision that distinguishes the U.S. restructuring philosophy underlying chapter 11 from the insolvency and liquidation protocols of many other countries that require the immediate appointment of a trustee to wind down the affairs of the estate upon the insolvency of the debtor. In contrast to such regimes, section 1108 is intended to effectuate the broad policy goals of chapter 11 to both rehabilitate the debtor and to maximize the value of the estate for creditors by allowing the debtor to remain “in possession” and continue to operate its business postpetition. The theory is that the debtor in possession (that is, in effect, the debtor’s management) is the best qualified to run the business of the debtor and to wrest control of the debtor and then replace the debtor’s management with a trustee in the early days of a chapter 11 case could be disastrous for the business of the debtor. The effect of section 1108 is to allow the debtor in possession to maintain its relationships with its customers, vendors (or suppliers), and employees to otherwise minimize the impact of the filing of the chapter 11 on the business of the debtor.
Section 1108 Represents a Departure from Pre-Code Practice
Section 1108 represents a departure from pre-Code practice that required the receiver, trustee, or debtor in possession to seek authority from the bankruptcy court to continue to operate the debtor postpetition. Section 1108 under the current Bankruptcy Code obviates the need for such a court order. See H. Rep. No. 95-595, 95th Cong., 2d Sess. 119 (1978); S. Rep. 95-989, 95th Cong., 2d Sess. 116 (1978) (“Thus, in a reorganization case, operation of the business will be the rule, and it will no longer be necessary to go to court to obtain an order authorizing operation.”).
Section 1108 Contains Limitations
The right of the debtor in possession (or trustee or receiver) to operate the debtor postpetition, of course, is not unfettered. Section 1108 provides authority for a party in interest to seek a court order to prevent the trustee from operating the debtor’s business. A motion under section 1108 might be brought, for example, by a creditors’ committee seeking to limit risky business activity by the debtor during the pendency of the chapter 11 case or to limit expensive research and development or exploration where a cost-benefit analysis of such expenses might indicate that such research and development or exploration is too highly speculative to be undertaken during the reorganization. Section 1108 expressly provides that a party in interest may bring a motion for an order to limit such operation of the debtor’s business. These limitations appear to be largely theoretical, however, as we were unable to find any such examples in published opinions where the court exercised its power under section 1108 to restrict or prohibit a debtor in possession from operating its business. At least one court has noted that the “orders otherwise” language in section 1108 “at most allows [a] court to direct the trustee to discontinue an enterprise . . . but it does not express or imply a power in court to condition trustee’s management of the estate.” In re Curlew Valley Assocs., 14 B.R. 506, 508 (Bankr. Ut. 1981). The court did note that a court can appropriately direct the trustee to cease operations of “a certain designated portion of the debtor’s business while permitting the trustee to continue operating the balance of such business.” Id. at 508, n.4. In that case, however, the court held that it would not entertain objections to a trustee’s conduct of the estate where that conduct involves “a business judgment made in good faith, upon a reasonable basis, and within the scope of his authority under the Code.” Id. at 514.
Although challenges to a debtor in possession’s operation of the debtor’s business are rarely brought under section 1108, restructuring attorneys should be well versed in section 1108, both because that power can be limited and because the power provided by that provision is unique from certain restructuring regimes of clients situated around the world.