New Bankruptcy Reform Bill May Make Business Reorganizations More Difficult
J. Robert Nelson
In April of this year, Congress approved amendments to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "Amendments"). While much of the focus has been on the stiffened requirements for personal bankruptcies, there are a number of changes, slated to take effect in October of this year, which will enhance creditor protection and significantly reduce the leverage of businesses pursuing bankruptcy reorganization.
Most companies that seek bankruptcy protection do so under substantial pressure from unpaid creditors - cash is in short supply, and it is not unusual for vendors to go unpaid and for leases and other contracts to slip into delinquency. By filing a bankruptcy petition, distressed companies gain at least temporary respite from creditor enforcement actions so that they can formulate a plan to deal with the pre-bankruptcy obligations. Some of that "breathing room" has been changed or even eliminated by the Amendments.
1. New Protections for Unpaid Vendors
Under the former law, vendors, upon timely notice, could reclaim identified goods delivered within ten days of a bankruptcy. However, if the goods were sold, reclamation was precluded. Under the new law, vendors now have 45 days to reclaim unsold goods. They also are given a priority administrative claim (a claim that must be paid in full prior to any reorganization) for the value of the goods that have been sold, or consumed, in the twenty days before a bankruptcy.
2. More Leverage for Commercial Landlords
Under prior laws, the Bankruptcy Court could, and frequently did, extend indefinitely the deadline for the debtor's decision to assume or reject a commercial lease. For companies with multiple locations, this afforded time to make decisions regarding profitable and unprofitable properties. The new law expedites the process, requiring that the assumption/rejection decision be made by no later than seven months after a bankruptcy filing. This may impose an early financial burden on debtors who, in order to assume leases, must cure, in cash, all prior payment defaults.
3. Failure to Submit a Timely Plan Forfeits Exclusivity
Under the former law, the Bankruptcy Code gave a debtor the exclusive right to propose a reorganization plan during the first 120 days of a case. This exclusivity afforded debtors leverage in defining their intentions for dealing with their creditors. This 120 day period of "exclusivity" could be, and often was, extended repeatedly by the Court. Under the Amendments, a debtor has up to 18 months after a bankruptcy filing to submit a reorganization plan. Failure to meet this deadline forfeits exclusivity, and no further extensions can be granted. Once the expiration occurs, creditors may file their own reorganization plans.
4. Amendments Address Debtor Stalling and Inattentive Behavior
The Amendments accelerate the reorganization process and provide sanctions for debtor inattention. As to the former, the Amendments mandate Court involvement in status conferences to assure prompt and economical resolution of bankruptcy cases. As to the latter, the Amendments provide for conversion to Chapter 7 liquidation or dismissal of cases based on gross mismanagement of the bankruptcy estate, failure to maintain appropriate insurance that poses a risk to the estate, unauthorized use of cash collateral substantially harmful to a creditor, failure to attend the scheduled meeting of creditors and failure to pay postposition taxes.
5. Insider Compensation Must Be Justified
Retention bonuses and severance pay have historically been used to incent key insiders to remain with a chapter 11 debtor. While approval of the Bankruptcy Court remains a requirement, the debtor must now prove that such incentives are essential by demonstrating that the insider has a bona fide job offer from another business at the same or greater compensation.
6. Recovery of Pre-Bankruptcy Payments to Creditors More Difficult
Under former law, payments made by debtors to creditors in the 90 days prior to bankruptcy could be recovered as preferences unless the payments were (1) made in the ordinary course of the business of the debtor and supplier (a subjective test) and (2) made according to ordinary business terms (an objective test). The new law replaces "and" with "or" and arguably makes it easier for creditors to defend against preference suits.
7. Small Business Reorganizations Simplified
Although the foregoing tend, on the whole, not to be debtor friendly, there is at least one provision that should simplify the reorganization process for small debtors (entities whose aggregate secured and unsecured debt is 2 million or less). Under current law, any company seeking bankruptcy reorganization is required to prepare a voluminous disclosure statement to assist creditors in voting on a reorganization plan. The new law provides substantially greater flexibility on this requirement as to small debtors. The Court, in determining adequacy of a disclosure statement, now may consider both the benefit and cost of providing additional information and, in certain cases, may even waive the requirement of a separate disclosure statement.
Businesses considering bankruptcy reorganization should anticipate the more stringent requirements imposed by the Amendments which, with few exceptions, will go into effect in October of this year.
Most companies that seek bankruptcy protection do so under substantial pressure from unpaid creditors - cash is in short supply, and it is not unusual for vendors to go unpaid and for leases and other contracts to slip into delinquency. By filing a bankruptcy petition, distressed companies gain at least temporary respite from creditor enforcement actions so that they can formulate a plan to deal with the pre-bankruptcy obligations. Some of that "breathing room" has been changed or even eliminated by the Amendments.
1. New Protections for Unpaid Vendors
Under the former law, vendors, upon timely notice, could reclaim identified goods delivered within ten days of a bankruptcy. However, if the goods were sold, reclamation was precluded. Under the new law, vendors now have 45 days to reclaim unsold goods. They also are given a priority administrative claim (a claim that must be paid in full prior to any reorganization) for the value of the goods that have been sold, or consumed, in the twenty days before a bankruptcy.
2. More Leverage for Commercial Landlords
Under prior laws, the Bankruptcy Court could, and frequently did, extend indefinitely the deadline for the debtor's decision to assume or reject a commercial lease. For companies with multiple locations, this afforded time to make decisions regarding profitable and unprofitable properties. The new law expedites the process, requiring that the assumption/rejection decision be made by no later than seven months after a bankruptcy filing. This may impose an early financial burden on debtors who, in order to assume leases, must cure, in cash, all prior payment defaults.
3. Failure to Submit a Timely Plan Forfeits Exclusivity
Under the former law, the Bankruptcy Code gave a debtor the exclusive right to propose a reorganization plan during the first 120 days of a case. This exclusivity afforded debtors leverage in defining their intentions for dealing with their creditors. This 120 day period of "exclusivity" could be, and often was, extended repeatedly by the Court. Under the Amendments, a debtor has up to 18 months after a bankruptcy filing to submit a reorganization plan. Failure to meet this deadline forfeits exclusivity, and no further extensions can be granted. Once the expiration occurs, creditors may file their own reorganization plans.
4. Amendments Address Debtor Stalling and Inattentive Behavior
The Amendments accelerate the reorganization process and provide sanctions for debtor inattention. As to the former, the Amendments mandate Court involvement in status conferences to assure prompt and economical resolution of bankruptcy cases. As to the latter, the Amendments provide for conversion to Chapter 7 liquidation or dismissal of cases based on gross mismanagement of the bankruptcy estate, failure to maintain appropriate insurance that poses a risk to the estate, unauthorized use of cash collateral substantially harmful to a creditor, failure to attend the scheduled meeting of creditors and failure to pay postposition taxes.
5. Insider Compensation Must Be Justified
Retention bonuses and severance pay have historically been used to incent key insiders to remain with a chapter 11 debtor. While approval of the Bankruptcy Court remains a requirement, the debtor must now prove that such incentives are essential by demonstrating that the insider has a bona fide job offer from another business at the same or greater compensation.
6. Recovery of Pre-Bankruptcy Payments to Creditors More Difficult
Under former law, payments made by debtors to creditors in the 90 days prior to bankruptcy could be recovered as preferences unless the payments were (1) made in the ordinary course of the business of the debtor and supplier (a subjective test) and (2) made according to ordinary business terms (an objective test). The new law replaces "and" with "or" and arguably makes it easier for creditors to defend against preference suits.
7. Small Business Reorganizations Simplified
Although the foregoing tend, on the whole, not to be debtor friendly, there is at least one provision that should simplify the reorganization process for small debtors (entities whose aggregate secured and unsecured debt is 2 million or less). Under current law, any company seeking bankruptcy reorganization is required to prepare a voluminous disclosure statement to assist creditors in voting on a reorganization plan. The new law provides substantially greater flexibility on this requirement as to small debtors. The Court, in determining adequacy of a disclosure statement, now may consider both the benefit and cost of providing additional information and, in certain cases, may even waive the requirement of a separate disclosure statement.
Businesses considering bankruptcy reorganization should anticipate the more stringent requirements imposed by the Amendments which, with few exceptions, will go into effect in October of this year.
Copyright 2005. Published for general informational purposes only, and should not be construed as legal advice. If you need legal advice please consult with your attorney.