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Barry  P. Caplan
503.243.1627
 

New Bankruptcy Rules Could Alter Businesses' Reorganization Plans

July 2005

Barry P. Caplan
503.243.1627

Published, Friday July 8, 2005 in The Daily Journal of Commerce

Utilities 
Chapter 11 has required Debtor's to provide adequate assurance of payment to utilities as of the Petition Date either by a security deposit or an allowed administrative expense claim.  The focus was to protect the utility without depleting the debtor's liquidity. 

The new act requires a cash deposit or cash equivalent (i.e., letter of credit or CD).  Granting of an administrative expense priority is not adequate. The utility can terminate service after 30 days without having to seek court permission. Thus, a Chapter 11 debtor will have to immediately commit substantial cash or its equivalent to merely keep the lights on.
  
Commercial Real Estate Leases
Section 365 of the Bankruptcy Code permitted the sale or assignment of commercial leases and even of their designation rights. Such opportunities were valuable and even provided liquidity where a debtor/ lessee had "under market" leases.

The new act radically restricts the previous practice. Presently, the debtor is permitted to obtain an extension for assuming a lease until plan confirmation. Landlords would continue to get paid but the debtor could wait to assume the lease after it determined a reorganization plan could be confirmed. 

The new act sets an outside limit for assumption or rejection at 210 days. The lease will be deemed rejected if not assumed within 120 days after the petition date. However, the court may authorize a 90 day extension for cause. Further, extensions would require prior written consent of the lessor. Other constituencies such as a lender or a creditor's committee are unable to seek extensions; it is only possible if the debtor or lessor agree.
 
Space does not permit discussion of other changes to Section 365. Prior provisions regarding commercial leases as a facilitating factor in reorganization are significantly more limited.

Vendors
A supplier to a Chapter 11 debtor will receive some benefits over the old law. For example, a creditor selling goods to the debtor in the ordinary course of the debtor's business may reclaim such goods (if the debtor received such goods while insolvent) within 45 days before commencement of the bankruptcy case. Demand must be in writing and the time period is extended 20 days if the 45 day period expires after the Chapter 11 filing. There are defenses if the goods are not still in inventory and if there, a secured creditor could have priority. The reclaiming creditor's remedy is to have the debtor return the remaining products. There will no longer be a monetary claim in the bankruptcy for the value of the reclamation claim.
 
Vendors will also have a new administrative expense claim for goods sold in the ordinary course of business if shipped to the debtor within 20 days prior to the filing.
 
Some New General Chapter 11 Provisions

Shorter Exclusivity Period
Although the plan exclusivity period of 120 days and confirmation deadline of 180 days remain, extensions of these periods are under the new act are limited to 18 and 20 months respectively.
  
Reduction of Recovery Actions
The act makes it more difficult to recover preference claims. The ordinary course defense in preference claims is broadened so that either the individual payment history or industry standards will suffice. Preferences under $5,000 are no longer avoidable. Preferences under $10,000 must be pursued in the district where the defendant is located not where the bankruptcy case is pending. Fraudulent conveyance actions will reach back to two years prior to the petition date. Certain inside transfers pursuant to employment contracts will also be more vulnerable.
 
Employee Retention 
The act extremely limits employee retention programs and golden parachutes for insiders in Chapter 11. In general, the provisions will make it more difficult to retain key personnel at a critical time. Failure to keep such key employees could result in more harm to a otherwise reorganizable debtor than the new law will help.

Conclusion
These are but a few of the coming changes to the reorganization of corporations in Chapter 11. While all of the hoopla has been about the effect of the new law on consumer bankruptcy, changes to business Chapter 11s could significantly limit the opportunities for reorganization success.

Related Practice Areas

Business Restructuring & Bankruptcy

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