Pre-Bankruptcy Issues for Consideration
- United States
- 01/23/2009
The key to a successful reorganization under Chapter 11 of the U.S. Bankruptcy Code is pre-bankruptcy planning. This article highlights some of the significant issues a prospective debtor will want to consider prior to filing for bankruptcy. While all of these issues are important, in any particular case the relative importance of these issues may vary.
Retention of Professionals
Without an experienced team of professionals, the successful reorganization of a debtor may never be possible. In connection with any Chapter 11 filing, time must be spent evaluating the proper mix of professionals that should be employed to guide the debtor through the bankruptcy process. Such professionals may include bankruptcy counsel, special counsel, financial advisors, investment bankers, accountants and turnaround management professionals. It is important that the prospective debtor select professionals who can work through the issues, alternatives and implications of the choices that will need to be made before and during the pendency of the Chapter 11 case. If properly assembled, the transition to a debtor-in-possession can be smooth and seamless.
Forum Selection
One of the key issues for a debtor and its professionals to consider when getting ready to file a Chapter 11 case is where to file. Because of differences in decisional law, choice of venue can have a significant impact on the progress and outcome of a Chapter 11 case. Certain jurisdictions, such as Delaware and the Southern District of New York, have become very popular venues due, in part, to the expertise of these courts in handling large Chapter 11 cases. When a corporation decides to file for bankruptcy, its choice of possible filing locations is determined by the statute that governs the venue of bankruptcy filings. Under this provision, corporate debtors can file for bankruptcy in any of four locations: (i.) the district where the corporation is domiciled, (ii.) the district where the debtor has its principal place of business, (iii.) the district where its principal assets are located or (iv.) any district where an affiliate of the debtor has already filed for bankruptcy. In preparing for a Chapter 11 filing, a debtor and its professionals must give serious thought to which venue is most likely to achieve the goals of the Chapter 11 filing.
Section 503(b)(9) Administrative Expense Claims
Section 503(b)(9) was added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). This section provides for an administrative expense claim for the value of goods that were sold to the debtor in the ordinary course of business and received by the debtor within 20 days before the commencement of the bankruptcy case. Before BAPCPA, a pre-petition vendor’s claim would have been classified as a general unsecured claim subject to certain potential reclamation rights of the vendor under state law. Now, Section 503(b)(9) grants pre-petition vendors an administrative claim that generally must be satisfied in full no later than the effective date of the confirmed Chapter 11 plan. As a cash-strapped debtor approaches a possible bankruptcy filing, it will now need to account for these additional cash demands as part of the budgeting process and make sure that it has sufficient cash to pay these claims in full. The debtor and its professionals also will need to discuss the timing of payment of Section 503(b)(9) claims and the effect that delaying such payments may have on suppliers’ willingness to continue shipping on normal terms.
Labor Issues
The WARN Act requires employers to give their employees 60 days’ notice before a mass layoff or plant closing. Except for specifically articulated exceptions, an employer who violates the WARN Act by ordering a plant closing or massive layoff without providing appropriate notice is liable to each aggrieved employee for back pay and benefits for the period of violation, up to 60 days. Case law holds that if an employee is terminated before the petition date, the employee is entitled to a fourth- or fifth-level priority claim over general unsecured creditors for up to $10,950, earned within the previous six months, and a general unsecured claim for other WARN Act damages in excess of the $10,950 cap, even where the 60-day period extends beyond the petition date. Conversely, if an employee is terminated on or after the petition date, the employee is entitled to a second-level administrative expense claim for any wages earned during the post-petition period, plus any additional WARN Act damages. Since the timing of a layoff or plant closing affects the priority afforded to the claims of the aggrieved employees, this is another key issue that a prospective debtor and its counsel will want to discuss before filing for bankruptcy protection. Failure to consider this issue may result in increased administrative expense claims for the already cash-strapped debtor.
Preference Payments
Most sophisticated creditors have become very familiar with the preference laws embodied in the Bankruptcy Code. Even unsophisticated creditors are aware that they might have to return funds received within 90 days of the bankruptcy filing, subject to certain defenses. Most practitioners advise their clients to accept preferential payments since it is better to negotiate with the money in hand. But what about the Chapter 11 debtor? Should it be counseled to make preference payments? Most Chapter 11 debtors have limited funds as they approach a bankruptcy filing. The need to conserve cash might militate against making such payments. On the other hand, the debtor might need critical supplies from certain key vendors, which might dictate a different approach. The ultimate decision might be a nuanced one, but this is one of the important issues that a prospective debtor will need to discuss with counsel before filing for bankruptcy.
Assumption and Rejection of Commercial Leases
Before the enactment of BAPCPA, Chapter 11 debtors who were tenants under commercial leases sought, and often received, numerous extensions of the 60-day deadline to assume or reject unexpired leases. In fact, in many courts, it was common for a debtor to receive an extension of this deadline through confirmation of a plan. As a result of BAPCPA, a Chapter 11 debtor no longer has unlimited time to determine whether to assume or reject commercial leases. Rather, lessees of commercial real estate only have 120 days after the commencement of a bankruptcy case to make a determination concerning the assumption or rejection of such commercial real estate leases. That period may be extended by a bankruptcy judge upon a showing of “cause,” but only for a period not to exceed 90 additional days. Accordingly, a debtor will have at least 120 days, but no more than 210 days, to determine whether to assume or reject commercial leases. Because of the narrow window provided to debtors to make this decision, a prospective debtor should begin the process of reviewing leases as early as possible. Depending on the amount of time available to review leases and address any critical issues, a prospective debtor may want to attempt to seek concessions from landlords before filing for bankruptcy. Landlords, especially in the current economic climate, are more receptive to negotiating lease modifications before a bankruptcy filing. This is because upon the filing of a bankruptcy case, a landlord may face the real possibility of rejection of the lease, an empty leasehold, and a minimal return on account of any lease rejection damages claim.
Critical Vendors
Upon filing for bankruptcy, a debtor often will seek authority from the court to pay immediately and in full certain pre-petition claims of those creditors deemed by the debtor to be critical. While courts in certain jurisdictions such as Delaware continue to approve critical vendor motions, others are no longer free to do so due to restrictions imposed by the appellate courts. Because conserving cash is an important goal for most Chapter 11 debtors, obtaining a critical vendor order can be a double-edged sword. On the one hand, a critical vendor order can enable the debtor to continue to do business with critical suppliers, obtain necessary inventory and normalize credit terms. On the other hand, a critical vendor order often results in a debtor and its professionals being inundated with requests from additional creditors wanting to be included as a critical vendor. Satisfying these additional requests can result in the debtor’s limited funds being further depleted. Should the debtor fail to comply with these additional requests, the debtor risks having important business relationships severed or severely truncated. Accordingly, the decision to request a critical vendor order is a decision that must be evaluated carefully.
Debtor-in-Possession Loans (DIP Loans)
Before filing a Chapter 11 case, a debtor must have a very good handle on its projected cash flow and related financing requirements. In a rare case, a Chapter 11 debtor can finance its operations solely from the use of cash collateral. In most cases, however, a Chapter 11 debtor requires post-petition debtor-in-possession financing. In the present economic conditions, most prospective Chapter 11 debtors are finding it difficult to secure DIP loans. Even where a prospective debtor is able to obtain DIP financing, the tight credit market has resulted in overly restrictive and extremely expensive DIP loans. Therefore, it is critical that a prospective debtor work with its bankruptcy professionals to evaluate potential DIP loans and to negotiate the best terms possible.
Payroll
When getting ready to file for Chapter 11 bankruptcy protection, it is important to review payroll and, if necessary, time the filing to address payroll issues to ensure a smooth transition into bankruptcy. The ability to have uninterrupted funding for wage and benefit obligations incurred before and immediately after a bankruptcy filing is crucial. Factors to be considered are sources of funding (e.g., unencumbered cash or lines of credit) and the timing of the filing in relation to pay periods. At all times, before and after a bankruptcy filing, the officers and directors of the company must take great care to assure that all funds withheld from employee wages for the payment of taxes and other obligations (e.g., health care premiums) are separately held and appropriately disbursed and not used for the payment of other debts of the company. Responsible officers can be found personally liable to the IRS for unpaid federal withholding taxes. If any wages and benefits that were earned for work performed before the bankruptcy filing remain unpaid, the company will usually seek bankruptcy court approval to pay such obligations promptly after the filing. Claims for unpaid wages and benefits accruing within 180 days before the bankruptcy filing have fourth- and fifth-level priorities under the Bankruptcy Code up to a total of $10,950 per employee.
Communication Procedures
A key issue for a prospective debtor seeking to reorganize in bankruptcy may be how to overcome negative publicity and turn media attention to an advantage. To this end, a prospective debtor and its professionals will want to identify and eliminate potential public relations problems and develop communications plans for crisis situations to protect the value of the organization. It is also important that a prospective debtor develop a unified message for employees and key vendors, and ensure that the lines of communication remain open. Developing and implementing communications procedures can mean the difference between a successful reorganization rather than a quick sale or liquidation.
