Corporate Bankruptcy 101 and Select Bankruptcy Issues - PowerPoint .ppt by handongqp

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									             Corporate Bankruptcy 101 &
              Select Bankruptcy Issues
                                             Morris S. Bauer, Esq.
                                                 Andrew Stein
                                             Larry K. Lesnik, Esq.

The material provided herein is for informational purposes
   only and is not intended as legal advice or counsel.
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Bankruptcy Filings On The Rise

 The Economic Indicators

Unemployment, Interest Rates, Housing
Market (Foreclosures), Stock Market,
Consumer Spending,Bad Credit-Card Debt
           Factors Leading to
           Financial Distress
•   Liquidity Crisis
•   Asset-Based Loan Default
•   Loss of Major Client/Customer
•   Loan Maturity and Unable to Refinance
•   Drop in Revenue
•   Increased Operating Costs
The Chapters Of Bankruptcy

        Chapter 7
        Chapter 9
        Chapter 11
        Chapter 13
        Chapter 15

   Utilization of the Chapter 11
• Reorganization
• Sale as a Going-Concern
• Orderly Liquidation

Who Can File a Chapter 11
  Corporations, Limited Liability
    Companies, Partnerships


            Commencement of a
             Chapter 11 Case
• Minimum Documents Necessary to File a Case:
   – Petition, Corporate Resolution, Creditor List, List of Twenty
     Largest Unsecured Creditors, and List of Equity Interest

• Timing:
   – Minutes With the Advent of Electronic Filing

       Commencement of a
       Chapter 11 Case (Cont.)
• Notice to Creditors:
  – Twenty Largest Will Receive Notice Within
    a Day of the Commencement Date (If
    Emergent First-Day Hearings Are

• Other Creditors Will Receive Notice
  Within Approximately Two Weeks
       Commencement Of a
       Chapter 11 Case (Cont.)
• Effect of Filing:
  – Automatic Stay (Section 362 of the
    Bankruptcy Code)
  – Requirement for Court Approval of Any
    Action Outside of the Ordinary Course of
  – Jurisdiction of Court Over Debtor’s Assets

           The Players
      What is a Debtor-in-Possession?

My company is losing money. I get to stay
 in control and keep collecting the same
compensation. What more can I ask for?

         Debtor’s Professionals
                  Who are they?

•   Counsel
•   Special Counsel
•   Chief Restructuring Officer
•   Accountants
•   Investment Bankers
•   Environmental Engineers
•   Brokers (real estate or business)
   Debtor’s Professionals
   How are they retained and how
         do they get paid?

   Retention Requirements

(No such thing as a free lunch!)
            United States
           Trustee’s Office
• Role: Monitoring Chapter 11 Cases
  – Conducting Committee Formation Meeting
  – Conducting Meeting of Creditors
  – Professional Retention and Fee Application
  – Quarterly Fees

        Types Of Creditors
• Banks (Pre-Petition Lenders)
• Equipment Lessors
• Landlords
• Trade Payables
• Taxing Authorities (Priority Claim)
• Priority Claims (Wages, Commissions,
  Benefits, including Union Claims)
• Equity Holders (Shareholders)
      Creditors’ Committee
• Formation Process
• Role of Committee
• Committee
• Compensation of
  Professionals and
  Committee Members

       Types of Notices Mailed to
•   Committee Formation Meeting
•   First Day Motions to Largest Unsecured Creditors
•   Notice of the Section 341 Meeting
•   Notice of Bar Date Along With a Proof of Claim Form
•   Notice of Sale of Assets
•   Notice of Settlements/Abandonment
•   Notice of Professional Fee Application Hearings
•   Notice of Disclosure Statement Hearing
•   Notice of Plan Confirmation
Representation of Creditors

          In-House Monitoring of
             Chapter 11 Cases
 Centralized Mailing Address for Bankruptcy Notices
 Bankruptcy Department to File Proofs of Claim, Note Important
  Dates, and to Receive Any and All Bankruptcy-Related
 Outside Counsel
 Forms and Letter Responses
    Proof of Claim Form
    Reclamation Demand Letter
    Response to Preference “Dunning” Letters
 Basic Knowledge of Preference Defenses
 Bankruptcy Rights With Respect to Contracts with Debtor
 Access to Pacer
• Doing Business With a Debtor
• Filing a Notice of Appearance
• Serve Reclamation Demand, if Applicable
• Adhere to the Deadline for Filing Proof of
• Analyze Potential Preference Exposure
• Be Cognizant of the Debtor’s Viability and
  Continuing Operations
• Motion Objecting to Claims
Should I Continue to Do
Business With a Debtor?
   Access to Financial
    Information of Debtor
   Business Terms
   Administrative Expense Claim
   Emotions v. Profit

        Available Information

• Schedules of Assets and Liabilities and
  Statement of Financial Affairs
• Monthly Operating Reports
• Counsel to Creditors Committee
• Other Creditors
• The Web (Newspaper Articles, etc.)
  – Court’s Website – Pacers
  – Newspaper Articles, ect.
 Administrative Claim – Automatic Administrative Claim for any
  goods received by the Debtor within 20 days prior to the Petition
   – Bar Date for filing Administrative Claim
   – Motion to Compel Payment of Administrative Claim
 Reclamation Demand - Within 20 days of the Petition Date,
  Creditor may serve demand on the Debtor for the return of
  goods received by the Debtor within 45 days prior to the Petition
 Defenses to Reclamation Demand
   – Subject goods no longer in possession of Debtor as of the
     Petition Date
   – Lender with a Lien on all Inventory, including subject goods
        Claims Process
• Bar Date (Deadline to File a Claim)

• Filing a Proof of Claim

• Motion Objecting to Claims

           Claims Trading
• What is it?

• Benefits of Selling Claim

• Risks of Selling Claim

      Andrew Stein
  General Attorney, AT&T
Bankruptcy claims are like junk in the attic.

Which makes more financial sense – donating what
you have to charity for a tax deduction, or trying year
after year to sell it for pennies on the dollar at a
garage sale?

You may not write off an account automatically just
because your customer has entered bankruptcy.
For claims that are more than de minimus, the IRS
requires objective evidence of worthlessness to
support a full or partial write-off.
In a bankruptcy, such objective evidence is usually
not available early on.

 THE BUYER gets an opportunity to realize a healthy
 return on a cash investment.

 THE SELLER gets instant cash and an accelerated
 tax benefit that the IRS is not likely to challenge.



$500,000 claim

14% cost of capital

40% effective tax rate

No objective evidence of worthlessness until the final
year of the bankruptcy

Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000

Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000

Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000

Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000

Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000

Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000

Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000

Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000

Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000

Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000

Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000

Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000


 Assumes risk that claim is valid

Assumes risk of percentage payout

            Preference Actions
                 Adding Insult to Injury
• Preference Payments – Typically, any payment
  received within 90 days of the Petition Date
• Dunning Letter from Debtor or Liquidating Trustee’s
• Defenses
   – Contemporaneous Exchange
   – New Value
   – Ordinary Course of Business or financial affairs of
     the debtor and the transferee or made according
     to ordinary business terms

   Personal Injury Claimants
• Automatic Stay Stops Litigation

• File Motion for Stay Relief to Seek
  Recovery from Insurance Carrier

         Executory Contracts
• An Executory Contract is a contract in which both
  parties still have continuing obligations

• Examples: Residential or Commercial Leases,
  Certain Equipment Leases, Service Contracts,
  License Agreements, and Collective Bargaining

• A non-Debtor party is required to continue with
  performance under the contract
    Executory Contracts (Cont.)
• Assumption/Rejection of a Lease

• Motion to Compel Assumption or Rejection

• Bankruptcy Code provides Debtor with a 120-
  day period to decide to assume or reject a
  non-residential lease, which period can be
  extended for an additional 90 days thereafter
  and further if consented to by the landlord.
• Debtor must assume or reject Non-
  Residential Lease within 210 days
  unless Landlord consents to further

• Debtor required to make all lease
  payments in accordance with lease
        Landlords (Cont.)
• Motion to Compel Assumption

• Relief From Stay to Terminate Lease

• Motion Seeking Adequate Protection

             Landlords (Cont.)
• Assumption of Lease
  – Adequate Assurance of Future Performance

  – Cure of Any Arrearages

• Assignment of Lease
  – Adequate Finances of Assignee

  – Shopping Center Leases

       Equipment Leases
      Equipment Financing
• True Lease vs. Disguised Security
• Motion for Stay Relief
• Motion for Adequate Protection
• Assumption of Lease
• Sale of Equipment
Time Line of A Chapter 11 Case

First Day Motions
• DIP Financing/Use of Cash Collateral
• Financial Reporting
• Sale or Liquidation of Business
• Plan of Reorganization/Plan of Orderly
      First Day Motions
“I filed Chapter 11 and I am now told I
can’t pay anyone (including employees)
until the Court says I can. What is the

     First Day Motions (Cont.)
• Use of Cash Collateral or Debtor-in-
  Possession Financing
• Payment of Wages and Other Employee
• Customer Refunds and Rebates
• Pre-Petition Critical Vendors
• Payment of Sales, Use and Other Taxes
• Maintaining Cash Management Systems
• Utility Companies
  First Day Motions (Cont.)
          Who is Served?
How quickly does the Court hear the
      Can they be opposed?
 What is the likelihood of the Court
denying the Debtor’s requested relief?

       DIP Financing vs. Cash
         What is Cash Collateral?
         What is DIP Financing?
How are creditors affected by DIP Financing
          versus Cash Collateral?

        Financial Reporting
• Schedules of Assets and Liabilities and
  Statement of Financial Affairs
• Budget for Use of Cash Collateral and DIP
• Monthly Operating Reports
• Disclosure Statement Provides Historical
  Financial Information and Forecasts

Sale of Assets in a
 Chapter 11 Case

          Types of Sales

• Asset Sale vs. Stock Purchase
• Section 363 vs. Plan of
• Higher and Better Offers
• Secured Creditor Sale/Foreclosure
 Chapter 11 Bankruptcy Sale
• Retention of an Investment Banker/Business
• Motion to Fix Bidding Procedures
  –   Bidding Procedures Hearing
  –   Standard Asset Purchase Agreement
  –   Stalking Horse Agreement
  –   Break-Up Fees
  –   Minimum Bids/Overbid
 Impact of a Chapter 11 Sale
• Sale Free and Clear of All Liens, Claims and
  – Successor Liability

• Assumption and Assignment of Executory
  – Payment of Arrearages
  – Adequate Assurance of Future Performance
 Plan of Reorganization and
Disclosure Statement Process

 The Debtor has the exclusive right to file
 a plan for a period of 120 days, which
 may be extended up to 18 months.

Competing Plans – Plan filed by Creditors

          Plan Negotiations

• Treatment of Secured Creditor, who is
  primary lender to the Debtor

• Negotiations with Creditors’ Committee

     Plan Negotiations from
     Committee Stand-Point
• Is the Debtor viable?
• What would unsecured creditors receive in a
• Are there claims against Insiders (leverage)?
• Are there claims against the Lenders, i.e.
  lender liability (leverage)?
• Are there avoidance claims against vendors?

     Plan of Reorganization
• Contents of Plan
• Classification of Claims
• Treatment of Claims

      Disclosure Statement
• Content: Similar to a Prospectus
• Provide Sufficient Information for a
  Reasonable Person to Vote on the Plan
• Notice of Disclosure Statement Hearing
• Objections to Disclosure Statement
• Approval of Disclosure Statement
 Requirements for Approval of
   Plan of Reorganization
• Consent of Impaired Classes of Creditors
• Fair Treatment of Creditors
   – Class of Creditors Must Receive More Than What
     They Would Receive in a Liquidation
   – Absolute Priority Rule -Junior Class of Creditors
     Cannot Receive Anything Until the Senior Class of
     Creditors is Paid in Full Unless Senior Class Consents
   – New Value
   – LaSalle – Is Equity Paying Fair Value to Retain
• Feasibility
• Cram-Down
  Plan of Orderly Liquidation
• Contents of Plan and Approval Process
• Liquidation Trust
• Assets Available for Unsecured Creditors
  – Remaining Sale Proceeds, if any
  – Preference Actions
  – Other Causes of Action

Questions and
Lunch Break
12:00 pm – 1:00 pm
             Corporate Bankruptcy 101 &
              Select Bankruptcy Issues
                                                  Ilana Volkov, Esq.
                                                Melissa A. Peña, Esq.
                                                James N. Lawlor, Esq.
                                                 Joseph Aronds, Esq.

The material provided herein is for informational purposes
   only and is not intended as legal advice or counsel.
Key Considerations For Landlords
When Faced With Commercial
Tenant’s Bankruptcy
   Presentation to New Jersey Corporate
           Counsel Association

             March 24, 2009

             Ilana Volkov, Esq.
               (201) 525-6269
Automatic Stay –
Sections 362 and 541

 Section 362(a) of the Bankruptcy
 Code prevents actions by landlords to
 obtain possession or exercise control
 over property of the estate.

Automatic Stay – Sections 362
and 541 (cont’d)
• Landlords must obtain relief from the
  automatic stay before taking any action
  against the bankrupt tenant or its property.
• Conversely, the automatic stay does not
  apply to any act by a lessor to obtain
  possession of the property covered by a
  lease that has terminated before the
  commencement of the bankruptcy case.
• A lease may be terminated by its own terms
  or, in New Jersey, upon issuance of a
  Judgment for Possession.               69
Ipso Facto Clauses – Section
• Ipso facto clauses permit non-
  debtor counter-party to terminate
  the contract or lease in the event
  of bankruptcy.
• Ipso facto clauses are not

Payment of Post-Petition Rent –
Section 365(d)(3)
• Landlord entitled to timely payment of
  post-petition lease obligations until
  such time as lease is rejected or
• Debtor’s obligations to pay lease
  obligations after the bankruptcy filing
  constitutes an administrative expense
  of the bankruptcy estate under Section
Payment of Post-Petition Rent –
Section 365(d)(3) (cont’d)

• The lease will govern what
  constitutes “rent.” To the extent
  so provided in the lease, “rent”
  includes rent, taxes, insurance,
  and CAM charges.
• “Stub” rent: “billing date” v.
  “accrual method” approach.
Assumption of Leases – Section
If a tenant opts to assume the lease, it must:

(1) cure or provide adequate assurance that it will
    cure defaults under the lease, including defaults
    related to non-monetary obligations under the
(2) compensate or provide adequate assurance that it
    will compensate the landlord for any actual
    pecuniary loss to the landlord resulting from the
    defaults; and
(3) provide adequate assurance of future
    performance under the lease.
Special Rules for Assumption of
Shopping Center Leases – Section
What is a “shopping center”?
• In re Joshua Slocum Ltd., 922 F.2d
  1081, 1087 (3d Cir. 1990).
• The Bankruptcy Code contains special
  rules for the assumption and
  assignment of shopping center leases
  in its prescription of what constitutes
  “adequate assurance of future
  performance”.                        74
Rejection of Commercial Leases
– Section 365(a), (g)
• If lease not formally assumed, it is
  deemed rejected by operation of law.
  Alternatively, tenant can formally
  reject the lease, subject to bankruptcy
  court approval.
• Rejection is the equivalent of a
  breach, deemed to occur on the
  petition date. Section 365(g).
Calculation of Rejection Damages -
Section 502(b)(6)

 If lease is rejected, landlord has a
 general unsecured claim for damages,
 subject to a cap.

Calculation of Rejection Damages -
Section 502(b)(6) (cont’d)
The cap limits the landlord’s damages claim to:

A. The rent reserved by such lease, without
    acceleration, for the greater of one year or 15
    percent, not to exceed three years, of the
    remaining term of such lease, following the earlier
   i. the date of the filing of the petition; and
   ii. the date on which such landlord repossessed,
        or the tenant surrendered, the leased property;
B. Any unpaid rent due under such lease, without
    acceleration, on the earlier of such dates. Section
    502(b)(6).                                    77
Calculation of Rejection Damages -
Section 502(b)(6) (cont’d)
• Split of authority exists as to whether
  “rent reserved” concept includes (and,
  therefore, caps) other costs incurred
  by landlord, such as repair and
• Duty to mitigate damages. In New
  Jersey, commercial landlords have a
  duty to mitigate their damages.
Calculation of Rejection Damages -
Section 502(b)(6) (cont’d)
• Landlord may use security deposit
  to offset total amount of lease
  rejection damages.
• Relief from the automatic stay is
  needed to set off a security
  deposit post-petition, except if
  security deposit took the form of a
  letter of credit.
Filing Proofs of Claim

• A chapter 11 petition commenced
  solely to cap a landlord’s claim for
  breach of a commercial property lease
  may be dismissed under appropriate
  facts and circumstances. In re
  Integrated Telecom Express Inc., 384
  F.3d 108, reh’g denied, 389 F.3d 423
  (3d Cir. 2004)
• Rejection of assumed leases         80
Timeline for Decisions Regarding
Assumption or Rejection – Section
• Tenants have 120 days from the
  bankruptcy filing to assume or reject
  the lease, although that deadline can
  be extended for another 90-days.
• Tenant must show “cause.”

Assignment of Leases to Third
Parties – Section 365(f)
Tenant can assign lease to third party
   so long as:
1. The tenant assumes the lease in
   accordance with Section 365(b) and
2. The assignee provides adequate
   assurance of future performance
   regardless of whether there has
   been a default.
Assignment of Leases to Third
Parties – Section 365(f)
• Anti-assignment clauses generally are not
  enforceable, where they are designed only to
  impair the debtor’s ability to assume the lease.
• Assignment relieves the estate of future liability
  under the lease. Section 365(k).
• If lease is assigned, lessor may require a deposit
  or other security for the performance of the
  debtor’s obligations under the lease substantially
  the same as would have been required by the
  landlord upon the initial leasing to a similar tenant.
  Section 365(l).
Avoidance Action Issues –
Section 547(b) and (c)
• If a landlord is sued for the recovery of
  preferential payments made before the
  tenant’s bankruptcy filing, the landlord could
  avoid liability if payments were made in the
  ordinary course of business.
• Additionally, if the lease ultimately is
  assumed, the pre-petition payments cannot
  be claimed as a preference.

Lease Auctions and Designation
• Before BAPCPA and the collapse of the
  economy, debtors routinely used lease
  auctions and designation rights sales to
  produce revenue for the estate, despite stiff
  opposition from landlords.
• Designation rights purchaser usually does
  not become the assignee under the lease.
  Once the assignee is identified, the debtor
  and assignee would have to demonstrate
  that Section 365(c) is satisfied.
Intellectual Property Licensing
 Agreements and Bankruptcy
        Executory Contracts
• A contract on which material performance
  remains due on both sides.

              IP Licenses
• Generally, courts have found that
  Intellectual Property Licenses are
  executory contracts as of the date a debtor
  files for bankruptcy when there are various
  future performance obligations owed by
  licensor and licensee.

          Intellectual Property
• Under Section 101(35A) of the Bankruptcy Code, intellectual
  property is defined as

  (A) trade secret;
  (B) invention, process, design, or plant protected under title 35;
  (C) patent application;
  (D) plant variety;
  (E) work of authorship protected under title 17; or
  (F) mask work protected under chapter 9 of title 17 to the extent
  protected by applicable non-bankruptcy law.

11 U.S.C. §101(35A).

        Exclusions to Definition of
          Intellectual Property
•   Trademarks
•   Trade names
•   Service mark licenses
•   Foreign Patents and Copyrights

 What happens when you are a licensee of
intellectual property and the licensor files for

• Section 365(n) of the Bankruptcy Code
  provides the licensee of an intellectual
  property license with protection.

           Pre-Rejection Period
What can you do prior to the Debtor’s decision to assume
or reject the licensing agreement?

 Under Section 365(n)(4) of the Bankruptcy Code, you
  can request that the Debtor continue to perform under
  the license pending the Debtor’s decision to assume or
 The statute requires the Debtor to perform OR turn over
  to the licensee the licensed property AND not interfere
  with the licensee's rights under the license, including the
  right to obtain the intellectual property (or embodiment)
  from a third party.
        Post-Rejection Period
• Termination - Once the Debtor rejects the
  license, the licensee can treat it as terminated.
• Licensee can now cease performance.
• Entitled to a general unsecured claim.
• ** Pre-Bankruptcy Planning – Since it will be
  difficult to determine the amount of damages,
  the license should be drafted to include a
  liquidated damage clause.

•    Under Section 365(n)(1), the licensee can elect “to
     retain its rights (including a right to enforce any
     exclusivity provision of such contract, but excluding
     any other right under applicable law to specific
     performance of such contract) under such contract and
     under any supplementary . . . as such rights existed
     immediately before the case commenced, for –
(i) the duration of such contract; and
(ii) any period for which such contract may be extended by
     the licensee as of right under applicable non-
     bankruptcy law.
11 U.S.C. § 365(n)(1)(B)(i) and (ii).                      95
• ** Pre-Bankruptcy Planning – Drafting
  Acknowledgment of Subject Matter as
  Intellectual Property and Applicability of
  Section 365(n).

• So you elected to retain the IP rights – now
  – Under Section 365(n)(2)(B) of the Bankruptcy Code,
    the licensee has to make all royalty payments for the
    duration of the license and any extension period.
  – Under Section 365(n)(2)(C) of the Bankruptcy Code,
    the licensee is deemed to have waived any right to
    setoff and any administrative claim arising from
    performance of such contract.

• ** Pre-Bankruptcy Planning – Drafting

Define royalties narrowly.

 Alternative Transaction Structures to
     Minimize Bankruptcy Impact
• Excluding Intellectual Property from
  Property of the Bankruptcy Estate
  – As set forth in Section 541 of the Bankruptcy
    Code, the commencement of a bankruptcy
    case creates an estate which consists of all
    legal or equitable interest of the Debtor in
    property, wherever it is located, as of the
    commencement of the case.
Vehicles to Exclude IP from the Estate

• (1) Assignment of Intellectual Property
• (2) IP Trusts
• (3) Bankruptcy Remote Entities

       Security Interest in IP
• Serves as a disincentive for the Debtor to
  reject the license.
• May be particularly helpful with Trademark

   Debtor is the Licensee

Can the Debtor assume and assign the
         license agreement?

                   The Exception
• Section 365(c)(1) of the Bankruptcy Code states that:

  The trustee may not assume or assign any executory contract . . . of
  the debtor, whether or not such contract or lease prohibits or
  restricts assignment of rights or delegation of duties if– (1)(A)
  applicable law excuses a party, other than the debtor, to such
  contract or lease from accepting performance from or rendering
  performance to any entity other than the debtor or the debtor in
  possession, whether or not such contract or lease prohibits or
  restricts assignment of rights or delegation of duties; and (B) such
  party does not consent to assumption or assignment . . .

11 U.S.C. § 365(c)(1)(A) and (B) (emphasis added).

    Can there be an assumption or
assignment under non-bankruptcy law?
•   Patent Licenses
     – Courts have found that patent licenses cannot be assumed or assigned by a
        debtor under Section 365(c)(1) of the Bankruptcy Code as federal law prohibits
        the assignment of a non-exclusive patent license without the consent of the
     – Courts have also found that exclusive patent licenses cannot be assumed or

•   Copyright Licenses
     – While few cases have addressed Section 365(c)(1) of the Bankruptcy Code and
       its applicability to copyright licenses, these courts have found that pursuant to
       federal copyright law, non-exclusive copyright licenses cannot be assumed and
       assigned in bankruptcy without the consent of the licensor.
     – Courts are split on whether exclusive copyright licenses can be assumed and
       assigned in bankruptcy.

 Hypothetical Test vs. Actual Test
• There is a conflict among the circuits as to
  the applicability of Section 365(c)(1) when
  a debtor licensee seeks to assume the
  license and has no intention of assigning
  the license to another party.

           Hypothetical Test
• The Third, Fourth, Ninth and Eleventh
  Circuit apply the “hypothetical test.”

• These circuits take a literal reading of
  Section 365(c)(1).

• The Debtor’s intention to assign the
  license is irrelevant.                     106
        The Harsh Result of the
         Hypothetical Test
• RCI Technology Corp. v. Sunterra Corp., 361
  F.3d 257(4th Cir. 2004) – The debtor entered
  into a license agreement with RCI whereby RCI
  granted the debtor a fully-paid irrevocable
  license to use RCI’s software in exchange for a
  $3.5 million license fee.
• Prior to the bankruptcy, the debtor paid the $3.5
  million license fee and expended $38 million in
  connection with modifying the licensed software.
• The debtor was not seeking to assign the
  agreement and only sought to assume the         107
        The Harsh Result of the
         Hypothetical Test (cont’d)
• RCI Technology Corp. v. Sunterra Corp., 361
  F.3d 257(4th Cir. 2004)
• The actual licensing agreement authorized the
  debtor licensee to assign the agreement.
• Applying the “hypothetical test”, the Fourth
  Circuit found that the license agreement could
  not be assumed notwithstanding the fact that the
  license agreement permitted an assignment to a
  purchaser of substantially all of the debtor’s
  assets.                                        108
To Avoid the Result in Sunterra Corp.
• ** Pre-Bankruptcy Drafting – The license
  agreement should explicitly provide for the
  licensor’s consent to assignment as well
  as consent to the Debtor’s assumption of
  the licensing agreement in the event of a
  bankruptcy filing.

              The Actual Test
• The First and Fifth Circuits apply the “actual test”
  in determining whether Section 365(c)(1)
  prohibits a debtor-licensee from assuming a
  license agreement.
• Under the “actual test”, the disjunctive “or” in
  Section 365(c)(1) (“The Trustee may not assume
  or assign . . . if excusable law excuses a party . .
  . from accepting performance from another entity
  . . .”) as the conjunctive “and”.
• Thus, a debtor is permitted to assume a license
  agreement provided that the debtor has no
  intention of assigning the contract.              110
 To Avoid the Result in Pasteur
• ** Pre-Bankruptcy Drafting – In the
  Pasteur case, the Court recognized that
  the licensor could have inserted
  restrictions in the cross-license which
  impacted the Debtor’s continued rights
  under the cross-license if there was a
  change in stock ownership or corporate
  control. Pasteur, supra at 494.

 Ipso Facto Termination Clause
• Can the licensor terminate the license
  pursuant to a provision in the agreement
  which authorizes the licensor to terminate
  the agreement upon the licensee’s filing
  for bankruptcy – an ipso facto termination

 Ipso Facto Termination Clause
• Exception to the General Rule –
   – Two Part Test Under Section 365(e)(2) of the Bankruptcy Code.
   – The prohibition against enforcement of the ipso facto termination
     clause does not apply if:
     “(i) applicable law excuses a party, other than the debtor, to such
     contract or lease from accepting performance or rendering
     performance to the trustee or to an assignee under such contract
     or lease, whether or not such contract or lease prohibits or
     restricts assignment of rights; and (ii) such party does not
     consent to such assumption or assignment . . .”
     11 U.S.C. § 365(e)(2).

    Unable to Assume License
• If the Debtor is unable to assume the license, is
  the license deemed rejected?
• Courts have allowed intellectual property
  licensing agreements to “ride through” the
  bankruptcy case.
• The “ride through” doctrines “provides that
  executory contracts that are neither affirmatively
  assumed or rejected by the debtor under
  Section 365, pass through the bankruptcy estate
  unaffected.” In re Hernandez, 287 B.R. 795, 799
  (Bankr. D. Az 2002).                             114
 Secured Creditor’s Foreclosure
Upon Debtor’s Intellectual Property
• When a secured creditor with a lien on all of the Debtor’s
  assets seeks to foreclose on intellectual property, which
  is the subject of a license agreement, Section 365(n)
  protects the licensee’s interest. The licensee can retain
  its interest in the intellectual property subject to the
  payment of royalties which are remitted to the secured
• This comports with Article 9 of the UCC. Section 9-
  321(b) provides that “[a] license in the ordinary course of
  business takes its rights under a nonexclusive license
  free of a security interest in the general intangible
  created by the licensor, even if the security interest is
  perfected and the licensee knows of its existence.” UCC
  9-321(b).                                                 115

            Materials prepared by James N. Lawlor
             Partner, Wollmuth Maher & Deutsch
               One Gateway Center, Ninth Floor
                       Newark, NJ 07102
                             - and -
                       500 Fifth Avenue
                      New York, NY 10110
                     Phone: 973-733-9200
                      All Rights Reserved

Key Terms in Bankruptcy Proceedings

  •   Chapter 11
  •   Chapter 7
  •   Chapter 13
  •   Property of the Estate
  •   Claims
  •   Secured vs. Unsecured Claims
  •   Prepetition vs. Postpetition Claims
Key Terms (cont’d)
   •   Discharge
   •   Automatic Stay
   •   Avoidance Actions
   •   Preferences
   •   Fraudulent Transfers
   •   Statements and Schedules

Key Parties In Interest

•   The Debtor-in-Possession
•   Chapter 11 Trustees
•   Chapter 7 Trustees
•   United States Trustee

Treatment of Prepetition Creditors
  •   The Debtor-Creditor Relationship
      •   Pre-Filing
           •   Governed by contract and applicable non-bankruptcy law
      •   Post -Filing
           •   The Automatic Stay comes into effect, barring actions to
               adjudicate or realize on debt
           •   Unsecured creditors must usually file a claim and wait
               until the conclusion of the proceeding to be paid, if at all
           •   Secured Creditors retain rights of priority but are still
               subject to the stay

Treatment of Creditors (cont’d)
•   Rights of Secured Creditors
    •   Pre-Filing
         •   Powerful rights, including right to foreclose, take
             possession of collateral and sell it to satisfy debt
    •   Post -Filing
         •   The Stay bars enforcement actions and stops
         •   Debtors often seek to use cash collateral to operate in
             reorganization proceedings
         •   Entitled to adequate protection for the collateral
         •   Secured creditors often need to seek stay relief to protect
             deteriorating assets, but are not assured that such relief
             will be granted

Treatment of Creditors (cont’d)
•   Contractual and Lease Relationships
    •   Pre-Filing
         •   Right to damages and to cease performing when other
             party breaches
    •   Post -Filing
         •   The Stay bars exercise of contractual rights against the
             Debtors and trustees
         •   Debtor is free to enforce its rights pending the conclusion
             of a Chapter 11
         •   Debtor can either assume or reject a lease or contract

Treatment of Creditors (cont’d)
•   Special Considerations as to Contracts
    •   Non-Debtor Recourse in the Face of
         •   May seek to compel Debtor to make a
             determination of whether to assume or reject a
             lease or contract on fairness grounds
    •   Agreements Terminated Prepetition
         •   Bankruptcy does not revive such agreements.

Treatment of Creditors (cont’d)
•   Special Considerations (cont’d)
    •   Non-Assumable Agreements
        •   Certain types of agreements may not be
            assumed by a debtor
    •   License Agreements/Shopping Center
        •   Special rules apply to licenses and shopping
            center leases in bankruptcy.

    Treatment of Creditors (cont’d)

•   Preventing Assignments of Contracts/Leases
    •   Pre-Filing
         •   Governed by contract and state law
    •   Post -Filing
         •   Anti-assignment clauses are generally not enforceable

Treatment of Creditors (cont’d)
•   Non-Competes/Restrictive Covenants
    •   Pre-Filing
         •   Enforceable as long as reasonable
    •   Post -Filing
         •   Bankruptcy will generally not eliminate the

Treatment of Creditors (cont’d)
 •   Right to Arbitrate Claims
     •   Pre-Filing
          •   Strong public policy for arbitration
     •   Post -Filing
          •   Bankruptcy courts follow the general rule that
              parties that specify arbitration of disputes will
              be required to arbitrate the amount and extent
              of claims

Creditors Transacting With
•   Creditors Engaged in Postpetition
    Transactions Are Protected
•   503(b) of the Code grants Priority
    treatment for services or goods
    provided to estate, as long as actual
    necessary costs and expenses of
    preserving the estate
•   Examples: wages, rents, repairs, taxes

Sometimes Forgotten Rights
•   Right of Recoupment and Setoff
    •   Recoupment
         •   Enforceable
    •   Setoff
         •   Can be lost through discharge and failure to
             seek stay relief
•   Reclamation
    •   Special rules apply that may elevate the claims of
        reclaiming creditors

Enhanced Claims of
•   Preferences
•   Fraudulent Transfer Claims

Questions and
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