Bankruptcy s Impact On Your and Other Creditors Business: How to Make the Bad News Better
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1 Bankruptcy s Impact On Your and Other Creditors Business: How to Make the Bad News Better Husch Blackwell LLP Ben Mann John Cruciani An Overview of Business Bankruptcy & Creditors Rights Issues June 26, pm CDT Benjamin F. Mann Partner Kansas City John J. Cruciani Partner Kansas City Husch Blackwell LLP
2 An Overview of Chapters 11, 9 and 7 of the Bankruptcy Code Chapter 11 Debtor remains in possession DIP (no trustee usually) Business operation continues Debtor reorganizes or sells business Unsecured Creditors Committee is involved in larger cases Operation of Business in Chapter 11 Debtor-in-Possession (DIP) Free to buy, sell and use property in ordinary course of business without court approval ( 1107 and 363(c)(1)) Use of cash collateral ( 363(c)(2)) Must provide adequate protection or get secured creditor s consent Borrow post-petition ( 364) DIP financing Critical payments and vendors (no statutory authority; court made rule) All of above usually occur in context of 1st-day" motions and hearings)
3 Operation of Business in Chapter 11 Creditors Committee Appointment by U.S. Trustee Representative of all unsecured creditors Whether to serve Sale of Assets ( 363) Out of ordinary course requires Court Approval Subject to higher bids at hearing Can be done without Plan or any vote of creditors Can be free and clear of liens and claims Chapter 11 Plans & Confirmation Debtor has the exclusive right to propose plan for 120 days ( 1121). This Deadline is often extended, maximum is 18 months. Plan & Disclosure Statement filed ( ) Debtor creates classes of creditors and proposes how to pay claims per class) Creditors vote on Plan by Class ( 1126) 2/3 in $ amount of those voting More than ½ in number of creditors of those voting Standards for Confirmation ( 1129(a)) 13 separate requirements
4 Chapter 11 Plans & Confirmation Major Requirements Pay all administrative expense and priority creditors in full Liquidation equivalent to each creditor At least one impaired class votes to accept Plan is feasible Cramdown ( 1129(b)) Plan can be confirmed without all classes accepting if: Secured creditors receive payments equal to value of liens Unsecured creditors 100% of claims or pro rata payment and no distribution to any junior claims or interest (the absolute priority rule) An Overview of Chapters 11, 9 and 7 of the Bankruptcy Code Chapter 9 Adjustment of debts of a Municipality (e.g. cities, counties, water/sewer districts, etc.) States themselves are not eligible (i.e. California can t file, but Orange County can) Debtor remains in possession, no trustee ever appointed
5 An Overview of Chapters 11, 9 and 7 of the Bankruptcy Code Unlike all other Chapters, Debtor must be insolvent (fail to pay debts as they come due or inability to pay in future) Chapter 9 Eligibility Requirements Must Meet the Definition of Municipality Must Have State Authorization to File Municipality Must Desire to put Together a Plan to Adjust its Debts Municipality Must Be Insolvent
6 General Requirements to Confirm a Chapter 9 Plan of Adjustment Must be proposed in good faith Must meet the best interests of creditors test: creditors must get at least what they would get if the case were dismissed and they could pursue whatever rights or remedies they had under state law The plan must be feasible Plan treatment must be fair and equitable to the non-accepting classes An Overview of Chapters 11, 9 and 7 of the Bankruptcy Code Chapter 7 Trustee appointed Immediate cessation of business (absent rare order, debtor should not be operating) Liquidation of all assets by a trustee or secured creditors
7 An Overview of Chapters 11, 9 and 7 of the Bankruptcy Code Chapter 7 The Trustee is the decision maker, subject to court approval Debtor does not normally have authority to resolve pre petition suits The majority of Chapter 7 cases (90%) are no asset cases Other Bankruptcy Chapters Chapter 12 Exclusively for Debtors that are family farmers (similar to Chapter 13) Chapter 13 An individual debt readjustment bankruptcy (Debtors make monthly payments for months) Chapter 15 Ancillary Proceedings for non-us bankruptcy proceedings for US assets
8 Action to Take Upon Knowledge of Bankruptcy Filing Insure compliance with Automatic Stay Evaluate 20 Day Claims and Reclamation Claims File Request for Notices Review Debtor s Schedules File Proof of Claim Review Status of Any Executory Contracts Preliminary assessment of preferential exposure and retain records Section The Automatic Stay Creditors are prohibited from the following automatically upon the bankruptcy filing Any act to collect debt Any act to foreclose or seize assets Any commencement or continuation of lawsuit Termination of contract Exercise of setoff rights There are exceptions to the automatic stay (e.g. criminal proceedings, state regulatory proceedings, certain financial contracts)
9 Section The Automatic Stay Relief from Stay To obtain your property or collateral No equity Not necessary for reorganization To obtain other relief For cause Lack of adequate protection Executory Contracts in Bankruptcy Governed by 365 of the Bankruptcy Code Includes contracts (including purchase orders) where performance is remaining on both sides (if only payment by Debtor remains not executory) Also includes unexpired leases
10 Executory Contracts in Bankruptcy Debtor s Options: Assume Assume & Assign Reject Executory Contracts in Bankruptcy Assumption Heaven Pay cure costs Continue performance Assignment: Must assume first Can assign even if prohibited by contract But assignee must show ability to perform
11 Executory Contracts in Bankruptcy Rejection: (a/k/a Hell) Not a termination but an authorized breach Damages caused by breach pre petition unsecured claim Executory Contracts in Bankruptcy Deadline on Debtor to Assume or Reject At time of Confirmation Hearing Post-Petition/Pre-Assumption or Rejection PURGATORY Creditor must keep performing but Debtor cannot be compelled to perform
12 Executory Contracts in Bankruptcy No protection in bankruptcy law But UCC Demand for adequate assurance of performance Remember: Every supplier relationship can be an executory contract to some extent Outstanding P.O.s that have been accepted are executory contracts and cannot be unilaterally cancelled or credit terms changed Special Rules Regarding Intellectual Property If the Debtor is the licensor and the IP contract is rejected, the licensee can either treat the contract as terminated or retain its rights under the contract. Proofs of Claim What Is It: A form (and supporting attachments) that puts the trustee, the court and the debtor on notice that a creditor is asserting it is owed some obligation by the bankruptcy estate
13 Proofs of Claim Many larger cases will send out customized proof of claim forms to creditors While most of the form is self-explanatory, it is important that it be filled out completely If the debtor is one of several jointly administered cases, be sure to file your proof of claim in the actual case for the debtor(s) that is obligated to you Attach or Summarize Documentation Many factors affect whether and how secured and priority creditors file proofs of claim Proofs of Claim When: (Chapters 7, 12 and 13) Most creditors must file a proof of claim within 90 days of the 341 meeting of creditors or such other separate notice that is mailed to all creditors When: (Chapters 11 and 9) A motion to establish a proof of claim deadline is filed and served Sometimes referred to as a claims bar date Creditors receive a copy of the notice of bar date
14 503(b)(9) Claims (20-Day Claims) Grants administrative expense priority for the value of any goods received by the debtor within 20 days before the commencement of the case if goods sold in the ordinary course of business New provision added by the 2005 BAPCPA amendments Provides administrative expense priority to certain pre petition claims Supplants reclamation rights except for claims between days before filing Unlike reclamation, no notice requirement Unlike reclamation, not subject to senior secured lender claims 503(b)(9) Claims (20-Day Claims) Scope of 503(b)(9) Applies to goods, not services Combination of goods and services Majority and minority views Goods must be received by debtor within 20 days before bankruptcy filing Value presumptively the invoice or purchase price Ordinary course
15 503(b)(9) Claims (20-Day Claims) Manner of asserting a 503(b)(9) claim No bankruptcy code provision or rule When as set by Court could be separate bar date or same bar date as for regular proofs of claim How to assert Proof of Claim (with or without section for 503(b)(9) claims) Separate form File application 503(b)(9) Claims (20-Day Claims) Payment on claim Generally not entitled to immediate payment But must be paid upon confirmation of Chapter 11 plan
16 What is a Preference? Generally: A payment or other transfer made by debtor to one of its creditors before bankruptcy that can later be recovered by the debtor or the trustee in a bankruptcy for re-distribution to all creditors The 5 Elements of a Preference A Transfer: That enables the creditor to receive more than if transfer had not occurred and there was a Chapter 7 liquidation of the debtor To or for the benefit of a creditor Made within 90 days (1 year for transfers to insiders) before bankruptcy filing date For or on account of an antecedent debt owed by debtor Transfer of debtor s property Made while debtor is insolvent
17 Preferences Preferences asserted 1½-2 years after bankruptcy filing After creditor takes hit on lost pre-petition amounts and maybe rejection of its executory contract The Debtor or Trustee must generally bring suit to recover a preference within 2 years of the bankruptcy filing date (but service may be delayed) Preferences Steps to minimize exposure when customer is a bankruptcy risk Convert to prepayments If reaching agreement to pay down old debt, reaffirm new sales will be paid according to terms and apply all payments first to current payables Avoid changing terms or practice that has existed for long period
18 Preferences What to do when bankruptcy is filed Determine preference exposure Maintain and secure payment history records and backup documents for two-year period before bankruptcy Make sure write-offs for bankruptcy are not reflected as paid Challenging Preference Claims There are several possible defenses to defeat some or all of a preference claim including, among others: Subsequent new value Ordinary course of business Contemporaneous exchange
19 Avoidance Powers A Trustee and DIP have same powers Strong-Arm Clause ( 544) power to avoid transaction which could be avoided by hypothetical lien creditor e.g. unperfected security interests and state law UFTA claims Invalidate certain statutory liens ( 545) Rent Which arise upon Debtor s insolvency Fraudulent Transfers & Obligations ( 548) Fraudulent Conveyances ( 548) Avoid transfers or obligations by Debtor if within 2 years of bankruptcy if Done with actual intent to hinder, delay or defraud present or future creditors OR In exchange for less than reasonably equivalent value and Debtor was insolvent in any of 3 ways Balance sheet Undercapitalized Unable to pay as come due
20 Setoffs ( 553) Common law rights preserved but exercise of rights stayed by automatic stay Limitations Mutuality Contractual Parties Strictly Construed Debtor affiliates Creditor affiliates Pre/Post Bankruptcy Distinction Other Limitations Acquiring claims to create setoffs within 90 days Setoffs done within 90 days if there is net improvement Recoupments Recoupment is not a bankruptcy concept, but rather common law. It requires that the claims arose out of the same transaction, without the timing requirements of setoff. Recoupment does not require that both claims arise before the petition date. Courts have often classified recoupment as a defense to payment by allowing one party to a transaction to withhold funds due to another party sufficient to recover an obligation owed by that other party and which arises from the same transaction
21 How to Improve the Plight of the Unsecured Creditor in Bankruptcy 1. Security Interest 2. Other Credit Enhancements a. Guaranties b. Letters of Credit c. Mechanics (or other statutory) liens 3. Credit Insurance
22 Advantages / Disadvantages in Bankruptcy for Secured Creditor Advantages: Potential for relief from stay to foreclose Each secured creditor is in separate class Interest and attorneys fees recoverable if creditor is oversecured Advantages / Disadvantages in Bankruptcy for Secured Creditor Disadvantages: Existing blanket lienholder has negative pledge Second lien position may have no value Delays in filing can create preferences
23 Other Credit Enhancements 1. Guaranty by Third Party Advantage: Not subject to automatic stay Disadvantage: Still subject to collection risks and costs 2. Letter of Credit Advantage: Disadvantage: Not subject to automatic stay Virtually no collection risks or costs Debtor reluctant to give because it costs money 3. Mechanics and Other Statutory Liens Key is to anticipate and complete filing steps Credit Insurance What is Credit Insurance? A contract with a third party that provides for payment to you in the event your customer doesn't pay or goes bankrupt Not as common in the U.S. as in other parts of the world, but it is becoming more popular
24 Credit Insurance Two major types of insurance Insurance for some or all of your A/R portfolio Insurance specific to a certain customer Credit Insurance Advantages of credit insurance Provide a guaranty of payment Not normally dependent on amount of bankruptcy distribution Hedges some of your credit risk Don't have to insure all of your potential exposure Peace of mind for a troublesome customer
25 Credit Insurance Disadvantages of credit insurance Can be extremely expensive Fully earned/non-refundable premiums If your claim is for goods with 503(b)(9) treatment, may not put you in a better position There are additional steps/items required compared to a typical bankruptcy You may not have purchased enough insurance Non-Bankruptcy Proceedings Receiverships ABCs State Law Insolvency Proceedings
26 Receiverships Receiverships Receiverships can be broadly or narrowly tailored to preserve and protect particular property interests Multiple possible parties involved: Lender may need a receiver for its collateral Subordinate party who has an interest Property owner that is the subject of the receivership Unsecured creditor ABCs Assignments for the Benefits of Creditors (ABCs) It is the voluntary state court equivalent to a Chapter 7 (liquidation) bankruptcy. An assignee is appointed. The assignee is assigned all assets of the debtor, and the assignee marshals and liquidates these assets for the collective benefit of the debtor s creditors. Typically only those creditors that assent receive distributions.
27 State Law Insolvency Proceedings Minority of states have statutory proceedings including preference recovery provisions Some have other bankruptcy type provisions (cash collateral usage and free and clear sales) e.g. Wisconsin and California Sole Source Suppliers Many times, a particular customer will be the only producer of a critical part or component for a product Financial distress or bankruptcy can interrupt the supply of this good or part
28 Sole Source Suppliers Alternatives may be available to attempt to keep the flow of goods uninterrupted Purchasing raw materials directly, prepaying for goods or other accommodations Important to try to recognize these situations as early as possible Often it is time-consuming to get another supplier approved and operational Particularly true for precision products Tooling/Dies/Goods in Possession of our Customers You may provide proprietary tooling or dies to customers who manufacture parts for us Important to look at any written agreement regarding ownership of tooling or dies
29 Tolling/Dies/Goods in Possession of our Customers UCC allows a financing statement to be filed as a "precautionary filing" to put the world on notice of our ownership rights Enter into bailment agreements to set forth the parties rights and obligations Better to do this when the relationship is good Tolling/Dies/Goods in Possession of our Customers If a customer files bankruptcy may want to seek relief from automatic stay to recover property. Also, important to monitor for asset sales to make sure they don t try to sell our tooling, dies or other proprietary products
30 Questions? Thank You! Ben Mann Partner Kansas City, MO John Cruciani Partner Kansas City, MO
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