"U.S. Bankruptcy Reform - Torys.qxp"
PRACTICE AREAS • 1 UNITED STATES because of the commencement of the case or non-payment of pre-petition debts unless the trustee or debtor, within 20 days of the order for relief, furnishes adequate assurance of payment BANKRUPTCY REFORM for post-petition services. The Act defines “assurance of pay- ment” to mean (i) a cash deposit, (ii) a letter of credit, (iii) a cer- LEGISLATION, 2005 tificate of deposit, (iv) a surety bond, (v) a prepayment of utility consumption, or (vi) another form of security that is mutually Prepared By: agreed on between the utility and the debtor or trustee. Expressly excluded as an acceptable assurance of payment is William F. Gray Jr., the debtor’s grant of an administrative expense priority claim, Tel: (212) 880-6336 • Fax (212) 682-0200 which had been the staple security offered to utilities. Debtors Email: firstname.lastname@example.org will now have to set aside funds to cover utility payments even & if they have sufficient post-petition operating cash flow to pay Alison D. Bauer utility expenses and the availability of administrative priority Tel: (212) 880-6048 • Fax (212) 682-0200 expense claims. The amount of adequate assurance is up to the Email: email@example.com court’s discretion. The Act also provides that a utility may set off against a pre-petition security deposit without notice or a Torys LLP court order. The definition of “utility” remains uncodified, 237 Park Ave however, and may continue to be the subject of litigation. New York NY 10017-3142 USA www.torys.com Sellers’ Reclamation Claim Rights Expanded. Reclaiming sellers of goods are given additional rights under the Act, The Bankruptcy Abuse Prevention and Consumer adding to the administrative expense of certain debtors with Protection Act of 2005 (the Act), enacted on April 20, 2005, retail stores or excessive inventory consumption. Sellers’ amended title 11 of the United States Code (the Bankruptcy claims for goods received by the debtor in the ordinary course Code). With noted exceptions, the Act became effective to of business within 20 days before bankruptcy may receive cases filed on or after October 17, 2005. While the Act has administrative expense status for the value of the goods. This been publicized chiefly as a reform of consumer bankruptcies, change will affect secured lenders as more cash goes to admin- many provisions affect business bankruptcy cases. istrative expenses, and some lenders may opt for liquidating Accordingly, this article summarizes the main changes affect- sooner rather than incurring mounting expenses. The increased ing business reorganizations. cash needs will affect the size of debtor-in-possession financing Advertising to Transportation PRACTICE AREA TEXTS of some debtors. The Act also sets the time frame for a seller’s Two basic themes pervade the reform legislation. First, written demand for reclamation to not later than 45 days after participants will have to pay for speed. As cases are expedit- the date of receipt of goods by the debtor, provided it is not ed, increased liquidity will be needed in the early stages of a later than 20 days after the date of the petition, if the 45-day bankruptcy case. Second, many provisions seek to curtail period expires after the date of the petition. white collar abuses. Tax Provisions Modified. The Act modifies the taxation of Commercial Landlords Get Relief. The Act extends to 120 individual and corporate debtors and the treatment of tax days, from 60, the initial time period within which the debtor claims and certain tax liens in bankruptcy cases. New section must decide to assume or reject an unexpired lease of non-res- 551 prescribes the interest rate on tax claims to be the rate idential property; but the Act allows the court to grant only a determined under applicable non-bankruptcy law (as opposed single extension for 90 days, on request of the debtor or lessor, to precedent case law requiring market rate). In proceedings for cause. Previously, debtors could, and in large retail chain before the US Tax Court, the automatic stay will apply only in cases often would, request numerous extensions of varying proceedings involving pre-petition taxes. The automatic stay lengths, sometimes through plan confirmation. Under the Act, also does not apply to taxing agencies that may now offset extensions beyond the single 90-day extension (seven months refunds owed to the debtor (as permitted under applicable non- in total) would require the lessor’s prior written consent. bankruptcy law) against tax liabilities owed by the debtor, each Landlords might have more leverage in negotiating cure with respect to taxable periods ending pre-petition. If the abili- amounts as the deadlines approach. Recognizing that a debtor ty to set off is not permitted under applicable non-bankruptcy must decide relatively quickly whether to assume or reject the law as a result of a pending action to determine the debtor’s tax lease and that assumption of a lease that is later rejected will liability, the taxing agency may hold the refund pending the result in a first priority administrative expense claim against the outcome of that action unless the court otherwise grants ade- estate, the Act limits the ensuing damages by reducing the quate protection of the taxing agency’s setoff right. In addition, administrative expense claims arising from rejection of a previ- for confirmation of a plan of reorganization, certain priority tax ously assumed lease to monetary obligations due within two claims must be paid in regular cash installment payments over years of the rejection date or date of actual turnover of the a period ending not later than five years after the petition date premises. Even with this limitation on administrative expenses, (previously under section 1129(a)(9), six years from the tax debtors can no longer wait until the plan stage to make deci- assessment date) and in a manner not less favourable than the sions on a sale of the business that will include selling, assum- most favoured non-priority unsecured class of claims provided ing or assigning leases. for in the plan (other than a convenience class). Another provi- Utilities Assured of Payment. Under section 366 of the sion elevates to administrative expense priority status the pay- Bankruptcy Code, a utility may not “alter, refuse or discontin- ment of certain secured and post-petition unsecured taxes ue service to, or discriminate against the trustee or debtor” incurred by the bankruptcy estate, including ad valorem prop- The 2006/2007 LEXPERT® CCCA/ACCJE Corporate Counsel Directory and Yearbook 2 • PRACTICE AREAS erty taxes, and further declares that governmental units should ness and the debtor received less than reasonably equivalent not be required to file a request for payment of an administra- value in exchange for the payments. This provision applies to tive expense relating to a tax liability or a tax penalty. The Act cases filed immediately on or after the enactment date. also redefines “adequate disclosure” for a Chapter 11 plan to include the full discussion of potentially material federal and Employees’ Claims Priority Expanded. The Act expands to state tax consequences of the plan to the debtor and a hypo- 180 days, from 90, the earnings period for granting priority sta- thetical investor that is representative of claimants in the case. tus to claims for wages and benefits, and raises the maximum Finally, failure of a debtor to timely file a tax return due post- amount entitled to priority to $10,000, from $4,625. The Act petition may result in dismissal or conversion of the case. instructs the court to order the reinstatement of retiree benefits if the debtor modified them during the 180 days prior to the fil- Preferences: “Ordinary Course” Defence Liberalized. ing of the petition and the debtor was insolvent on the date of Other provisions deal with the bankruptcy trustee’s avoidance the modification (unless the court finds that the balance of powers. Under the Bankruptcy Code, a transfer of property that equities clearly favours the modification). These amendments was made within 90 days before the bankruptcy filing (one apply to all cases filed on or after the enactment date. year for insiders) on account of a prior debt while the debtor was insolvent may be voided as a preference. The Act simpli- KERP Payments Severely Scaled Back. Reacting to a wide- fies the “ordinary course” defense invoked by a transferee to a spread sense that Key Employee Retention Plans (KERPs) have preference claim under section 547(c)(2) of the Bankruptcy become excessive, Congress prescribes in the Act guidelines Code by requiring that the transferee prove either that the trans- for denying as an allowed administrative expense certain reten- fer was made in the ordinary course of business between the tion bonuses, severance payments and other transfers or obli- debtor and transferee (course of conduct between the parties) gations incurred for the benefit of officers, managers or or that the transfer was made according to ordinary business consultants after the date of the bankruptcy filing. The Act pro- terms (industry standards). Previously, a transferee had to prove hibits payments and obligations to an insider for the purpose of both factors to defend against a preference action. Pre-petition inducing the insider to remain with the debtor’s business transfers of less than $5,000 will be exempt from attack in busi- unless (i) the payment or obligation “is essential to the reten- ness bankruptcy cases. With respect to purchase money loans, tion of the person because the individual has a bona fide offer where a creditor makes a loan to enable the debtor to purchase from another business at the same or greater rate of compensa- an asset on which the creditor will take a lien, the time for per- tion”; (ii) “the services provided by the person are essential to fection of the lien is extended to 30 days, from 20, after the the survival of the business”; and (iii) either the amount of pay- debtor receives possession of the asset so that the transfer may ment does not exceed 10 times the mean of similar payments not be avoided. With respect to all other collateral, the transfer made to non-management employees “for any purpose during will not be avoided if the creditor perfects its lien within 30 the calendar year” or, if no such payments were made, 25% of days of the lien grant. With respect to all adversary proceed- any similar transfer made to the insider in the prior calendar ings, including preference actions, the venue provisions have year. Severance payments to an insider are prohibited unless been amended so that adversary proceedings brought against a the payment is part of a severance program generally available non-insider defendant for less than $10,000 may be brought to full-time employees and the insider’s severance payment only in the district where the defendant resides (as opposed to does not exceed 10 times the mean severance given to non- where the bankruptcy case is located). management employees in the same calendar year. Debtors are also prohibited from making transfers to any officers, man- Fraudulent Conveyances: Look-Back Period Extended. agers or consultants hired after the petition date if such trans- The Bankruptcy Code also allows for the transfer of a debtor’s fers are outside the ordinary course of business and are not interest in property or the incurrence of an obligation to be justified by the facts and circumstances of the case. Thus pay- voided as a fraudulent conveyance if it was made or incurred ments to turnaround managers that are hired by the debtor will with the intent to hinder, delay or defraud a creditor or made be limited. It is left to the court’s discretion if the “facts and cir- for less than reasonably equivalent value and the debtor (i) was cumstances” warrant payment. While these amendments insolvent or rendered insolvent; (ii) had unreasonably small intend to curb excessive bonus and compensation packages, capital; or (iii) could not pay its debts as they came due. The management might be disinclined to suggest commencing a Act extends the period for avoiding fraudulent transfers under bankruptcy case and less likely to stay once commenced. Cases section 548 of the Bankruptcy Code to two years, from one filed since the effective date have sought court approval of per- year, prior to the petition date. This provision extending the formance-goal–based incentives for management in lieu of the look-back period for fraudulent transfers applies only to cases former retention bonuses. filed after April 20, 2006, one year after the enactment date. The Act does not amend the ability of a debtor to avoid a trans- Financial Contracts Redefined. Particular provisions rede- fer under Bankruptcy Code section 544 by applying applicable fine specified financial contracts, such as forward contracts, state laws prohibiting fraudulent transfers, which typically have repurchase agreements and swap agreements, and revise a longer look-back period. guidelines governing transfers and repudiation of qualified financial contracts. Retention Bonuses Subject to Fraudulent Conveyance Scrutiny. The Act also permits the avoidance, as a fraudulent Fraud Watchdog Empowered. The Act requires that the transfer/obligation, of payments made to an insider under an United States Trustee move for the appointment of a Chapter employment contract, without considering the solvency or 11 trustee if there are “reasonable grounds to suspect” that cur- financial condition of the debtor at the time the transfer was rent members of the governing body of the debtor, the CEO, made/obligation incurred or contract executed, if the trans- the CFO or members of the governing body who selected the fer/obligation was outside the debtor’s ordinary course of busi- CEO or CFO have participated in “actual fraud, dishonesty, or The 2006/2007 LEXPERT® CCCA/ACCJE Corporate Counsel Directory and Yearbook PRACTICE AREAS • 3 criminal conduct in the management of the debtor or the mass tort liabilities. Courts may nevertheless use case manage- debtor’s public financial reporting.” This provision is applica- ment orders to defer hearings on disclosure statements or plans ble to all cases filed after the enactment date. While the stan- or schedule together confirmation hearings for multiple plans. dards for the appointment of the Chapter 11 trustee have not Prepackaged Cases Expedited. The Act attempts to foster been altered, the provision will likely increase pre-petition and expedite prepackaged cases (cases in which the debtor has turnover in companies and the placement of turnaround man- solicited acceptances before the commencement of the case). agers as boards remove individuals involved in questionable It does this, first, by authorizing a bankruptcy court to order the pre-petition activities. United States Trustee not to convene a section 341 meeting of Investment Banker Retention Expanded. The Act provides creditors if the debtor has filed a prepackaged plan and solicit- for new conflict-of-interest rules that allow a debtor’s pre- ed acceptances. This limits the ability of United States Trustees bankruptcy investment banker (or its counsel) to continue as a in some jurisdictions to oppose the confirmation of a plan prior bankruptcy investment banker (or counsel) under section to a 341 meeting. Second, the Act allows for the continued 327(a) to provide advisory services in the case, even if it had solicitation of acceptances or rejections from claim holders underwritten securities of the debtor. To be retained, the before the commencement of the case (therefore, without a investment bank must still satisfy the other “disinterested” court-approved disclosure statement) if such solicitation com- requirements—namely, that it must not be a creditor or equity plies with applicable non-bankruptcy laws (such as securities holder of the debtor and not have any interest materially laws). Previously, creditors could delay a prepackaged plan by adverse to the interest of the debtor’s estate or any class of cred- filing an involuntary petition before the end of the solicitation itors or equity security holders. This provision will increase period and stopping the solicitation until a disclosure statement competition in the financial advisory sector. was approved. Committees Democratized. Section 1102 of the Small Business Bankruptcy Cases Reformed. The Act Bankruptcy Code, which provides for creditors’ and equity defines a small business debtor as one with less than $2 million security holders’ committees, has been modified to authorize a in aggregate, non-contingent, liquidated secured and unse- court, on request of a party in interest, to order the United cured debts as of the date of the petition. It sets forth mandato- States Trustee to change the membership of an official com- ry factors for determining the adequacy of disclosure mittee appointed if the court determines that the change is nec- statements of small business reorganizations. It directs the essary to ensure adequate representation. The court may also Judicial Conference of the United States to propose standard- order the United States Trustee to increase the number of mem- ized disclosure statements and plans of reorganization for small bers on a committee to include a small business creditor who business debtors; and it sets forth uniform national reporting might otherwise have been excluded from the committee requirements for these debtors. Advertising to Transportation PRACTICE AREA TEXTS (because of the size of the claim) if such creditor’s claims in comparison with its annual gross revenue are disproportion- Cross-Border Insolvencies Facilitated. The Act creates a ately large. The Act also provides for increased communication new Chapter 15 that incorporates, with slight modification, the to creditors by requiring that committees provide access to Model Law on Cross-Border Insolvency, which was originally information to creditors, solicit and receive feedback from proposed by the United Nations Commission on International creditors and upon court order, produce additional reports and Trade Law (UNCITRAL) in 1997. Chapter 15 establishes a disclosures. mechanism for dealing with cross-border insolvency cases and the coordination and cooperation between US courts, trustees, Conversion/Dismissal Grounds Expanded. The Act modi- debtors and their foreign counterparts. It delineates who may fies section 1112 to expand the grounds for conversion or dis- be eligible for ancillary relief, the procedure for filing an ancil- missal of a Chapter 11 case. The court must convert/dismiss a lary case, the rights and duties of a debtor, the rights of credi- case if the movant establishes “cause” (now defined under the tors, the principles that a court must abide by in granting relief, Bankruptcy Code) absent unusual circumstances that are and various other matters involving foreign debtors. Although specifically identified by the court and that establish that the the Act repealed prior section 304, which governed cases conversion/dismissal is not in the best interests of creditors and ancillary to a foreign proceeding, the core principles of section the estate. The court shall not convert/dismiss if an objecting 304 are retained in Chapter 15 and cases interpreting section party proves that (i) there is a reasonable likelihood that a plan 304 will continue as precedents for interpreting Chapter 15. A will be confirmed within the exclusivity periods or within a Chapter 15 proceeding is commenced by a “foreign represen- reasonable time, and (ii) the grounds for granting conver- tative” filing directly with the bankruptcy court a petition for sion/dismissal include an act or omission that can be reason- recognition of the “foreign proceeding.” In contrast to the defi- ably justified and cured within a reasonable time frame. A nition of a “foreign proceeding” as applied under former sec- hearing on conversion/dismissal must be held no later than 30 tion 304, Chapter 15 does not limit foreign proceedings to days after the filing of the motion, and the court must render a those pending in the debtor's home country in which its domi- decision no later than 15 days after the hearing. cile, residence, principal assets or principal place of business Exclusivity: Playing Field Levelled. The Act provides that were located. Instead, recognition may be obtained as either a the periods of exclusivity for filing a plan of reorganization and “foreign main proceeding” or a “foreign non-main proceed- soliciting votes may not be extended beyond 18 months and ing.” Foreign main proceedings are those pending in the coun- 20 months, respectively, after the petition date. While the pur- try where the debtor has the “center of its main interests.” pose is to level the playing field and have cases confirmed Foreign non-main proceedings are already ancillary proceed- quicker by limiting the discretion of bankruptcy courts to ings in a country where the debtor has an “establishment,” extend exclusivity, it may result in more liquidating plans being which is defined as any place of operations where the debtor filed or plans filed without resolution of key issues, such as carries out a non-transitory economic activity. Representatives The 2006/2007 LEXPERT® CCCA/ACCJE Corporate Counsel Directory and Yearbook 4 • PRACTICE AREAS of foreign non-main proceedings have less access to courts and property (section 549); (v) the ability to acquire property on reduced court remedies than the representatives of foreign behalf of the estate that is not subject to any lien resulting from main proceedings. After the filing of a petition, but before the any security agreement entered into by the debtor before the bankruptcy court has ruled on the petition and granted “recog- commencement of the case (section 552); and (vi) the ability of nition,” the court may grant provisional relief to protect the the foreign representative to operate the debtor’s business. assets of the debtor or interests of the creditors. Upon recogni- Upon recognition of a foreign main or non-main proceeding, tion of a “foreign main proceedings,” unlike under section 304, the foreign representative may request addition provisional several provisions of the Bankruptcy Code automatically apply relief. The first order under Chapter 15 granting recognition to property within the territorial jurisdiction of the United and relief in aid of a foreign main proceeding was entered in States: (i) the granting of adequate protection to creditors (sec- December 2005 by Judge Robert Lifland in the Bankruptcy tion 361); (ii) the enforcement of the automatic stay (section Court for the Southern District of New York in In re La 362), which applies immediately upon recognition of a foreign Mutuelle du Mans Assurances IARD UK Branch MMA main proceeding; (iii) the use, sale or lease of property (section Account, No. 05-60100. 363); (iv) the avoidance of certain post-petition transfers of The 2006/2007 LEXPERT® CCCA/ACCJE Corporate Counsel Directory and Yearbook