New England Biz Law Update
The recently enacted Bankruptcy Code reforms are the most comprehensive changes to federal bankruptcy law since enactment of the Code in 1978.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 takes effect on Oct. 17 and will apply to bankruptcy cases filed on and after that date. While the Act’s provisions affecting individuals (who typically file under Chapter 7 or Chapter 13) have been well-publicized, the Act also contains many provisions affecting Chapter 11 business reorganizations.
Some increase creditors’ rights, while others restrict debtors’ rights or increase their responsibilities. Overall, it appears likely that the Act will make reorganization under Chapter 11 more expensive and difficult and will buttress the trend toward use of Chapter 11 to liquidate rather than reorganize financially distressed businesses. Pre-petition planning and preparation will continue to be important ingredients for a successful Chapter 11 reorganization.
This article merely touches on several of the significant changes to Chapter 11 reorganization resulting from the Act. The Act’s focus on increased creditor protections and increased debtor responsibilities and time pressures ensures that pre-petition planning and preparation will continue to be important steps to a successful Chapter 11 reorganization.
Below are some of the Act’s significant changes affecting Chapter 11.
Small Businesses
A Chapter 11 debtor whose non-contingent, liquidated debts total less than $2 million (excluding debts to affiliates and insiders), and in whose case a creditors’ committee has not been appointed or is determined not to be providing effective oversight of the debtor, will be subject to increased reporting requirements and increased supervision by the bankruptcy court and the United States Trustee, an official with administrative oversight over bankruptcy cases.
Such small-business debtors will also be required to file a plan within 300 days after filing for Chapter 11, and obtain confirmation of the plan within 45 days after filing it. These additional responsibilities may prove burdensome to some small businesses and potentially could interfere with their ability to reorganize.
Plan Exclusivity
Under existing law, a debtor has the exclusive right for 120 days after the petition date to file a plan, and an additional 60 days to solicit acceptance of a plan filed by the 120-day deadline. These deadlines may be shortened (though they rarely are) or extended for cause, and the debtor’s exclusivity period is often extended for lengthy periods of time, sometimes years, in cases involving large, complex business enterprises, or where there is no creditor constituency seeking to file its own plan.
Under the Act, the 120-day and 180-day exclusivity periods cannot be extended past 18 months and 20 months, respectively. These absolute deadlines for exclusivity should provide a motivated, well-managed debtor with ample time to negotiate and file a plan, but do but create the potential for increased pressure on debtors in large, complex cases.
Commercial Leases
Under current law, a debtor must within 60 days after the petition date assume or reject a nonresidential lease of real property where the debtor is lessee, or the lease will be deemed rejected. However, debtors can almost always extend the deadline for assuming or rejecting such leases until plan confirmation or closing of a Section 363 sale of assets, so long as the debtor performs its post-petition lease obligations.
Under the Act, the deadline by which a debtor must assume or reject such nonresidential leases is increased to 120 days and may be extended for a maximum of 90 additional days, but after 210 days the debtor’s decision to assume or reject the lease may be further delayed only with the consent of the landlord.
This change gives landlords immense leverage in negotiations with debtors on lease disposition, and will require some debtors to assume or reject leases before they are certain of the ultimate benefit (or detriment) of doing so.
The Act does limit any landlord claim for subsequent rejection of an assumed lease to two years’ lease obligations, and provides that non-monetary defaults incapable of cure need not be cured in order to assume a lease. But these “debtor-friendly” provisions pale in significance to the increased leverage afforded landlords by the Act’s absolute assume-or-reject deadline.
Creditors’ Committees
Under current law, formation of creditors’ committees in Chapter 11 cases is handled by the U.S. Trustee. Typically the U.S. Trustee will appoint the five or seven largest creditors willing to serve.
The Act provides that a smaller creditor may serve on the committee if its claim against the debtor represents a significant portion of its annual revenues, and involves the bankruptcy court in committee formation. The Act also imposes new duties upon committees, which now will be required to share information with and solicit the opinions of their creditor constituencies.
Overall, these changes may result in more diversified committees and greater creditor participation in the reorganization process, but they may also chill creditors’ willingness to serve on committees and increase the administrative costs associated with committees. Priority Claims/Utility Deposits
The Act expands the universe of claims entitled to priority (i.e., full payment before any payments to general unsecured creditors). For example, the Act increases to $10,000 the amount of an employee’s pre-petition wages and benefits that will be entitled to priority treatment – more than twice the amount afforded under existing law.
The Act also grants priority status to all claims for goods sold to a debtor in the ordinary course of business and received by the debtor during the 20 days immediately preceding the Chapter 11 filing. A related provision expands creditors’ reclamation rights, which often give rise to priority administrative expense claims.
And debtors will no longer be able to obtain post-petition utility service by providing utilities with administrative claims. The Act requires debtors to post cash deposits or other collateral to continue post-petition utility service.
These changes, while favorable to affected creditors/vendors, will place greater demands on debtors’ cash flow and may adversely affect their ability to reorganize.
Health Care Cases
In a Chapter 11 case involving a debtor engaged in a health care business such as a long-term care facility, the court must appoint a health-care ombudsman within 30 days to monitor and report on patient care. Health care debtors will be subject to specific responsibilities concerning patient records.
Any debtor closing a health care facility must do so in accordance with new rules governing transfer of patients to another facility. Again, these changes are likely to increase the cost of reorganizing a health care business.
A. Davis Whitesell is a member of Cohn Whitesell & Goldberg LLP, a Boston firm specializing in representation of financially-distressed businesses in Chapter 11 and in out-of-court workouts and restructurings. Mr. Whitesell has 20 years’ experience in representing debtors, trustees, creditors and committees in Chapter 11 cases. His firm maintains a “Troubled Company Resource Center” at the firm’s website, www.cwg11.com.
