Last week we discussed how the new Bankruptcy Abuse and Consumer Protection Act, passed in response to heavy lobbying by the credit card industry, makes attaining Chapters 7 and 13 protection more difficult for the consumer. The law also poses potential problems for businesses attempting to reorganize under Chapter 11, a fact largely overlooked by the media.
As basic background, Chapter 11 allows a business debtor, with approval of its creditors and the bankruptcy court, to repay a portion of its debt under conditions prescribed by the debtor. When a debtor files a Chapter 11 case, its managers remain in place and are given breathing room to devise a plan of reorganization. This plan establishes how much of the debt will be paid and the time frame in which creditors will receive payment. The creditors may vote to accept or reject the plan, and if it’s accepted and then confirmed by the court, the business pays its creditors accordingly and, if all goes well, eventually returns to profitability.
Until now, the bankruptcy courts have exercised discretionary authority throughout this process to ensure that the progress of a case was commensurate with a debtor’s efforts towards reorganization. This discretion has proved vital to the recovery of many prominent businesses over the years. Yet the new Bankruptcy Code, in establishing more rigid rules and speeding up Chapter 11 proceedings, robs the bankruptcy courts of much discretionary authority.
For example, under the new code, a business debtor now has 120 days to provide the court with a proposed plan of reorganization. The court may extend the 120-day period, but is not permitted to do so beyond a date that is 18 months after the business debtor filed bankruptcy.
If a business debtor fails to file a timely plan of reorganization, the creditors are permitted to propose a plan. Alternatively, the creditors can move to have the case dismissed or converted to a case under Chapter 7 (liquidation).
In contrast, under the old code, although business debtors had 120 days to file a plan of reorganization, bankruptcy courts had wide discretion to give business debtors as much time as needed and warranted to file a plan. Many times, especially in larger cases, a bankruptcy court would extend the 120-day period far beyond the maximum time permitted under the new code.
Ames Department Stores, for example, was given almost two years to file its plan of reorganization. This extra time allowed Ames to emerge from bankruptcy in 1992 and become the nation’s fourth-largest discount retail chain, trailing only Wal-Mart, Kmart and Target. (Ames eventually closed its doors in 2002, but this was because of debt related to the 1998 acquisition of Hills Store Co. of Massachusetts.)
Another example of the new code’s rigidity is the amount of time it gives a business debtor to assume or reject its leases. Especially for retail chains, having adequate time to evaluate leases is crucial. A debtor with many locations must ascertain the profitability of each of its stores so that it can eliminate the leases of less profitable locations and keep those stores that will enable it to successfully emerge from bankruptcy.
Under the new code, a lease is deemed rejected if it is not assumed or rejected by the earlier of two dates: 120 days after the initial filing or the date that the bankruptcy court approves a plan of reorganization. The bankruptcy court is permitted to grant only one extension for 90 days. Any subsequent extensions may be granted by the bankruptcy court only with written consent of the landlord.
Under the old code, business debtors had only 60 days to make an initial determination about leases. But bankruptcy courts could and would exercise discretion in extending that period far beyond the time now allowed. One well known business was given more than a year to determine which leases it wanted to reject or keep. In part due to the old code’s flexibility, that business was afforded ample time to make informed decisions in this regard and consequently was able to emerge from bankruptcy successfully.
The new code also restricts a debtor’s ability to recover payments made to creditors just before filing bankruptcy.
With certain exceptions, the old code allowed a business debtor to recover monies it paid to creditors within the 90-day period prior to filing. This protected those creditors that would otherwise receive much less from a debtor’s estate as a result of pre-bankruptcy payments made to more preferred creditors.
Under the new code, however, a business debtor is precluded from recovering pre-bankruptcy payments totaling less than $5,000. (Under the old code, the amount was $600.) Additionally, the new code makes it easier for creditors to keep pre-bankruptcy payments that are purportedly made in the ordinary course of business.
Thanks to the credit card industry, businesses struggling to reorganize and return to profitability will face more troublesome Chapter 11 proceedings. If you are interested in reading more about the changes in the Bankruptcy Code, we suggest the 2005 Supplement to the Collier Portable Pamphlet of the Bankruptcy Code and Additional Statutory Provisions. This publication contains the changes made to the Bankruptcy Code, as well as section-by-section analysis.