WANDA BORGES, ESQ. BORGES & ASSOCIATES, LLC 575 UNDERHILL BLVD. SYOSSET, NY 11791 516-677-8200 x 225 [email protected] 0 TRMG - BUSINESS WITH A DEBTOR

COPING WITH A CHAPTER 11 PROCEEDING AND A DEBTOR IN

POSSESSION DURING ITS CHAPTER 11

WANDA BORGES, ESQ. BORGES & ASSOCIATES, LLC

575 UNDERHILL BLVD.SYOSSET, NY 11791516-677-8200 x 225

[email protected]

1TRMG - BUSINESS WITH A DEBTOR IN POSSESSION -

2011

TRMG - BUSINESS WITH A DEBTOR IN POSSESSION - 2011

SUMMARY OF A SUCCESSFUL CHAPTER 11 PROCEEDING

Debtor obtains First Day Orders Creditors’ Committee is Formed Debtor Operates as a Debtor-in-

Possession SOMETIMES there is a Sales of Assets PLAN OF

REORGANIZATION/LIQUIDATION ACCEPTANCE CONFIRMATION EMERGENCE FROM CHAPTER 11

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SUMMARY OF A CHAPTER 11 PROCEEDING

FORMATION OF CREDITORS’ COMMITTEE

◦ Generally 7 largest unsecured creditors◦ Prepetition committee may be appointed◦ Party in interest may petition court to change

membership of the committee◦ Small business may be added◦ More than one committee may be appointed

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SUMMARY OF A CHAPTER 11 PROCEEDING

FUNCTION OF CREDITORS’ COMMITTEE◦ Investigate into the Financial Affairs of the Debtor

Prior to Chapter 11 Proceeding During Chapter 11 Proceeding

◦ Negotiate a Plan of Reorganization Debtor has a viable business and can reorganize with

payments to creditors◦ Negotiate a Liquidation/Sale

Debtor cannot survive in business Sell all the assets to a third party as a “going concern” Sell all the assets piecemeal.

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POST-PETITION SALES to a DEBTOR-IN-POSSESSION (DIP)

POST-PETITION SALES are PRIORITY ADMINISTRATIVE EXPENSES

◦ On an even footing with ALL other priority administrative expenses, including attorneys’ fees, accountants’ fees, post-petition wages, etc.

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POST-PETITION SALES – FIRST STEPS

◦ NOT necessary to obtain a new credit application All financial information will be available through the court

filings

◦ The DIP is a new/different legal entity Don’t mix old credits with new transactions

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EXTENDING CREDIT TO A DIP

◦ If you extend credit there is the risk that you can be “burned” twice

◦ Don’t accept any payments on pre-petition debts UNLESS there is a court order

◦ Don’t let a DIP account get old Requires constant monitoring

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SELLING TO A CHAPTER 11 DEBTOR[Can the DIP Pay its Bills?]

First Day Motion to Obtain Financing or Use Cash Collateral provides substantial financial information◦ Read declaration/affidavit/affirmation in support of

First Day Motions Budget appended to Financing Motion or

Motion to Use Cash Collateral tells you what the DIP cash flow is expected to be

Monthly Operating Reports give monthly data on an ongoing basis

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FIRST DAY MOTIONS

Important Information for Creditor Contemplating Sales to the Debtor-in-Possession◦ DIP FINANCING MOTION

Lets you know how much cash the debtor will obtain Read the Financing Stipulation for terms of borrowing “Carve Out” for US Trustee, Committee Professionals,

Other Professionals What kind of security is given the Lender Read the Budget

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FIRST DAY MOTIONS

Important Information for Creditor Contemplating Sales to the Debtor-in-Possession◦ MOTION TO USE CASH COLLATERAL – money

received by the debtor from the sale of its assets Lets you know the bank is unfriendly

Bank sometimes objects Debtor needs its cash to buy new product to sell Budget most important to determine what kind of cash

DIP will have to buy new products Look for other points similar to Financing Order

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SELLING TO A CHAPTER 11 DEBTOR

Monthly Operating Reports give monthly data on an ongoing basis◦ Receipts and Disbursements◦ a/r reconciliation and aging◦ a/p and secured payments report◦ Inventory and Fixed Assets Report◦ Summary of Bank Activity◦ Check Register◦ Detail of Investment Accounts, Petty Cash, Report of

Taxes Owed and Due◦ Officer or Owner Compensation◦ Significant Developments

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SELLING TO A CHAPTER 11 DEBTOR

Considerations if you have a 503(b)(9) Priority Administrative Claim

Considerations if You are a Critical/Essential Vendor

Considerations if you have a pre-petition security interest

Considerations if you are merely a pre-petition unsecured creditor

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POST-PETITION SALES

BEFORE YOU DECIDE TO SELL TO A DIP, PROTECT YOUR PRE-PETITION CLAIM

◦ Are you a Critical/Essential Vendor?

◦ Do you have a Personal Guaranty?

◦ Did you receive any preference payments?

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CRITICAL VENDOR ORDERS

● Doctrine of Necessity

● Creditor essential to debtor’s business operations

● Debtor will be forced to buy goods for cash in advance or COD

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● Cost of goods or services from different vendor much greater● Debtor cannot get goods or services anywhere else● Debtor has favorable contract with vendor● Vendor threatening not to sell to debtor at all

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SELLING TO A CHAPTER 11 DEBTORConsiderations if You are a Critical/Essential

Vendor

◦ Are you getting paid in full for your pre-petition claim?

◦ Are you receiving some of your money now and some later?

◦ Debtor’s attempt to bind you to prepetition standard terms and conditions

◦ Debtor’s attempt to bind you to prepetition credit extension

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CRITICAL VENDOR RECENT DECISION

In re Corner Home Care, Inc. (U.S. Bankruptcy Court, Western District, Kentucky)

Critical Vendor Relief Denied◦ No proof that Debtor could not obtain goods from vendor’s

competitors◦ No proof that vendor would not sell to Debtor on any terms◦ No proof that vendor was obligated to continue selling to

Debtor

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● QUID PRO QUO● Creditors receiving critical vendor status must agree to extend post-petition credit● other requirements

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CRITICAL VENDOR DEMANDS BY THE DIP

■ agree to continue to supply goods and services based on “Customary Terms”

■ Continue to supply goods or services on an uninterrupted basis

■ No credit limit or cap

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CRITICAL VENDOR DEMANDS BY THE DIP

SAMPLE (Cooper Automotive)

“On the Filing Date, the Debtors requested authority to pay pre-bankruptcy claims of certain suppliers in recognition of the importance of the Debtors’ relationships with these suppliers… order authorizing the Debtors, under certain conditions, to pay the prepetition claims of certain trade creditors that agree to the terms set forth below and to be bound by the terms of the Final Order”

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● Only Debtor determines who will be deemed critical● Accept no payments without a court

order ● Not always granted

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SELLING TO A CHAPTER 11 DEBTORCAVEAT!!!!!!

■Acceptance of payment and Agreement to Terms IS BINDING UPON CREDITOR

■Creditor who arbitrarily changes its mind: ▪ Creditor to repay all prepetition money it has been paid ▪ Creditor can be held in contempt

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SELLING TO A CHAPTER 11 DEBTORAS A CRITICAL VENDOR:

PREFERENCE ISSUES

■Payment received AFTER the critical vendor order is signed is NOT recoverable as a preference

■ Payment received PRIOR to the bankruptcy filing and during the 90 day preference period MAY be recoverable as a preference ▪ Creditor should insist on a preference waiver in its contract with the debtor

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OTHER WAYS TO DO BUSINESS WITH THE DEBTOR-IN-POSSESSION

EXECUTORY CONTRACTS

DEFINITION◦ ONE WHERE SOME FUTURE ACT IS TO BE DONE

(Black’s Law Dictionary)◦ ONE IN WHICH A PARTY HAS MATERIAL

UNPERFORMED OBLIGATIONS (Wikipedia)◦ No definition in the Bankruptcy Code

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WRITTEN EXECUTORY CONTRACTS

Requirements Agreement

Consignment Agreement

Service Agreement

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EXECUTORY CONTRACTS AND THE BANKRUPTCY CODE

11 U.S.C. §365(d)(2) authorizes a debtor to assume or reject any executory contract subject to court approval◦ Defaults must be cured or adequate assurance

must be provided◦ Creditor must be compensated for any actual

pecuniary damage due to default◦ Adequate assurance of future performance must

be given

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EXECUTORY CONTRACTS DEFINITIONS

◦ ASSUMPTION all prepetition monies paid Adequate assurance of future performance

◦ REJECTION contract is terminated No future action Creditors’ prepetition claim becomes a general

unsecured claim

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EXECUTORY CONTRACTS ASSUMPTION OR REJECTION

Debtor has absolute right to assume or reject

No strict deadline Debtor must decide before Plan

Confirmation

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CREDITOR CAN FORCE ISSUE

Motion to Compel may be filed 11 U.S.C. §365(d) provides:

◦ On request of any party to contract◦ Court may order the trustee/debtor to determine

within specified period of time to assume or reject such contract

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REASONS TO FORCE THE ISSUE

Creditor doesn’t want to be stuck with contract

Creditor wants to work with another entity Contract is really unfavorable Creditor wants/needs to get paid its

prepetition debt

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COURT GUIDELINES

Importance of Contract to Debtor’s business and reorganization

Debtor’s failure or ability to satisfy post-petition obligations

Damage the non-debtor will suffer Exclusivity intact or terminated Has debtor had sufficient time to appraise

its financial situation

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ADVANTAGES OF “FORCING THE ISSUE”

Debtor may agree to release creditor from contract

Creditor may be able to negotiate more favorable terms

Debtor may agree to deadline Cases of Note:

◦ Quebecor◦ Lyondell◦ Cooper

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UNILATERAL ACTION DANGEROUS

Failure to fulfill terms of any executory contract can find the creditor in contempt of automatic stay

Long Term Contracts = Executory Contracts Court may issue OSC to hold creditor in

contempt◦ Metaldyne◦ Visteone

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SELLING TO A CHAPTER 11 DEBTORConsiderations if You are MERELY a Pre-Petition

Unsecured Creditor

■Very Little Recourse

■ Decide what you can afford to lose

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STRATEGIES TO DETERMINE IF A CHAPTER 11 WILL BE SUCCESSFUL

■ Budget – Review the Budget appended to any of the

Financing Orders- Monitor the Debtor’s spending in relation to its

Budget- Debtor may over-spend and bank may pull the

plug

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CAVEAT

■NO GUARANTIES: Beware the expression “Don’t worry you are guaranteed to be paid for post-petition goods/services”

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CAN A CREDITOR PROTECT ITSELF AGAINST A LIUIDATION

▪ Creditor cannot prevent a liquidation

▪ Sales Motions• Will every post-petition creditor get paid in full?• Stop selling except for cash or L/C

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SELLING TO A CHAPTER 11 DEBTORPRIORITY ORDER IN EVENT OF CHAPTER 7 CONVERSION

■Secured Creditors get paid before anyone else TO THE EXTENT THE COLLATERAL EXISTS ▪ Watch in particular – Superpriority Post-Petition liens

■Administrative Expense Claims get paid next and ALL equal to one another▪ Beware the administratively insolvent estate

■List of Pre-petition Priority contained in §507 of the Code

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WHAT TO DO WITH THAT PERSONAL GUARANTY WHEN THE BUSINESS IS IN CHAPTER 11 OR 7

● Make sure you have the right kind of guaranty

● Differentiation between Guaranties ● Guaranty of Payment - GOODA requirement to pay immediately upon a default in payment by the primary debtor

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TRMG - BUSINESS WITH A DEBTOR IN POSSESSION - 2011 40

GUARANTIES

● Guaranty of Payment Recommended LanguageThe Guarantor acknowledges that this Guarantee is a Guarantee of Payment, and the Guarantor’s obligations under this Guarantee are and shall at all times continue to be absolute and unconditional in all respects, and shall at all times be valid and enforceable irrespective of any other agreements or circumstances of any nature whatsoever which might otherwise constitute a defense to this Guarantee and the obligations of the Guarantor under this Guarantee or the obligations of any other person or party (including, without limitation, the Customer) relating to this Guarantee or the obligations of the Guarantor hereunder.


GUARANTIES

● Differentiation between Guaranties ● Guaranty of Collection - BAD

● All collection efforts must be exhausted first before the credit grantor can seek recovery from the guarantor

● Chapter 11 or 7 must be completed so that distribution is determined

● Collection efforts can only proceed after business entity is OUT of bankruptcy

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GUARANTIES

● Maintain Original Document ● The original minimizes the possibility that the guarantor will claim fraud or forgery ● Without original, the guarantor will have a better case to claim forgery ● Using a copy will not always be fatal

● Best Evidence Rule permits a copy PROVIDED there is no

dispute over authenticity of original

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NEWEST TREND

CREDITOR MUST ACT IMMEDIATELY◦ ACT AS SOON AS PLAN AND DISCLOSURE

STATEMENT ARE FILED◦ ACTUALLY A CONFIRMATION ISSUE◦ OBJECT TO THE DISCLOSURE STATEMENT◦ IF NO RESOLUTION

OBJECT TO CONFIRMATION

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NEWEST TREND

RELEASE TO A NON-DEBTOR◦ Creditor accepts this release by accepting Plan

of Reorganization◦ Unwary creditor may not notice it◦ Generally no separate notice on ballot

One Judge in Pennsylvania mandates that the ballot contains a CAVEAT that acceptance of the plan will also constitute acceptance of the release provisions

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NEWEST TREND

RELEASE TO A NON-DEBTOR◦ Included as a provision in chapter 11 plan◦ Not hidden – but certainly not highlighted◦ All guaranties are wiped out

45


PREFERENCE DEFINITION

ANY TRANSFER OF AN INTEREST OF THE DEBTOR IN PROPERTY

◦TO OR FOR THE BENEFIT OF A CREDITOR;

◦FOR OR ON ACCOUNT OF AN ANTECEDENT DEBT OWED BY THE DEBTOR BEFORE SUCH TRANSFER WAS MADE;

◦MADE WHILE THE DEBTOR WAS INSOLVENT;

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●


PREFERENCE DEFINITION

ANY TRANSFER OF AN INTEREST OF THE DEBTOR IN PROPERTY

◦ MADE – ON OR WITHIN 90 DAYS BEFORE THE DATE OF THE FILING OF THE

PETITION; OR BETWEEN NINETY DAYS AND ONE YEAR BEFORE THE DATE OF THE

FILING OF THE PETITION, IF SUCH CREDITOR AT THE TIME OF SUCH TRANSFER WAS AN INSIDER; AND

◦ THAT ENABLES SUCH CREDITOR TO RECEIVE MORE THAN SUCH CREDITOR WOULD RECEIVE IF – THE CASE WERE A CASE UNDER CHAPTER 7 OF THIS TITLE THE TRANSFER HAD NOT BEEN MADE; AND SUCH CREDITOR RECEIVED PAYMENT OF SUCH DEBT TO THE EXTENT

PROVIDED BY THE PROVISIONS OF THIS TITLE

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CONTEMPORANEOUS EXCHANGE FOR NEW VALUE DEFENSES

CONTEMPORANEOUS EXCHANGE FOR VALUE (COD or CIA)

◦ Transfer was intended by debtor and creditor to be contemporaneous exchange for new value and

◦ Transfer was substantially contemporaneous exchange (e.g. check tendered for delivery of goods, COD transactions)

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NEW VALUE DEFENSES

New Value Given after Transfer

◦ Creditor extending credit to debtor after payment that was not secured and not paid by otherwise unavoidable transfer

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Paid for New Value? Split among the Circuits!◦Counts: 4th, 5th, 8th and 9th Circuits◦Does not count: 3rd (?) 7th and 11th Circuits U.S. Bankruptcy Court Delaware’s decision in

In re Pillowtex allows paid new value U.S. Bankruptcy Court Eastern District of

Pennsylvania’s recent decision In re Frey Mechanical Group allows paid new value

◦Other Circuits: 1st, 2nd, 6th, 10th, and D.C.? Lower courts are weighing in!

PAID FOR NEW VALUE AS A DEFENSE

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Yes – Commissary Operations – U.S. Bankruptcy Court, Middle District of Tennessee

No – TI Acquisition LLCNo – Circuit City


CAN FULLY PAID SECTION 503(b)(9) PRIORITY CLAIM COUNT AS

NEW VALUE

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ORDINARY COURSE OF BUSINESS DEFENSE

ORDINARY COURSE OF BUSINESS DEFENSE

TRANSFER WAS IN PAYMENT OF A DEBT INCURRED BY THE DEBTOR IN THE ORDINARY COURSE OF BUSINESS OR FINANCIAL AFFAIRS OF THE DEBTOR AND THE TRANSFEREE; AND

◦ SUBJECTIVE TEST – MADE IN THE ORDINARY COURSE OF BUSINESS OR FINANCIAL AFFAIRS OF THE DEBTOR AND THE TRANSFEREE; OR

◦ OBJECTIVE TEST – MADE ACCORDING TO ORDINARY BUSINESS TERMS

52


PREFERENCES UNDER BAPCPA

PROTECTION OF VALID PURCHASE MONEY SECURITY INTERESTS

PROTECTION OF REFINANCE OF SECURITY INTEREST

PROTECTION AGAINST PAYMENTS RECEIVED IN ACCORDANCE WITH AN ALTERNATIVE REPAYMENT PLAN CREATED BY A CREDIT COUNSELING AGENCY

53


PREFERENCE STATUTE OF LIMITATIONS

The later of two years after the order for relief or one year after the appointment or election of the first trustee if it occurs before the expiration of the two year period.

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PREFERENCES UNDER BAPCPA

VENUE OF CERTAIN PROCEEDINGS◦ LESS THAN $5,850 IN THE AGGREGATE

NO preference action to be commenced Trustees most likely to send demand letter anyway

◦ MORE THAN $5,850 BUT LESS THAN $11,725 ACTION ONLY IN FEDERAL DISTRICT COURT WHERE

DEFENDANT RESIDES CERTAIN COURTS HAVE REFUSED TO RECOGNIZE THIS

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Funds Provided to Debtor to Pay Specific Indebtedness Is Not Property of Debtor

◦ Transfer Did Not Disadvantage Other Creditors◦ Theory is Based on Whether -

the Debtor had the right to disburse the funds to whomever it wished– or

the Debtor was compelled by a third party (sometimes a new creditor/lender) to disburse the funds to one particular creditor or a group of creditors

Effectively Destroys Concept of Preference – because◦ Transfer is NOT of property in which Debtor has an

interest


LESSER KNOWN PREFERENCE ISSUES: EARMARKING DEFENSE

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A Trustee May Recover a Preference From an Initial Transferee

Mere Conduit Defense says That the One Who Received the Transfer is Not an Initial Transferee But Only a Recipient

Theory is That the Recipient of Preferential Transfer is Not a Transferee but Only a Mere Conduit For the Transfers


LITTLE KNOWN OR USED PREFERENCE DEFENSE: MERE CONDUIT

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Mere Conduit Defense Must Show

◦ no dominion over the funds no right to use the money for its own purposes no legal ownership or title to the funds

◦ no control over the funds funds merely pass through one’s hands Conduit is a fiduciary Conduit is under explicit instructions regarding the funds

◦ courts must step back and evaluate a transaction in its entirety (equitable remedy)


LITTLE KNOWN OR USED PREFERENCE DEFENSE: MERE CONDUIT

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SALE OF CLAIMS: SELLER GOALS

Immediate Cash Realization

Avoids Risk of Smaller Distribution

Avoids Risk of Delayed Distribution

Avoids Risk of Distribution in Less Liquid, More Speculative Assets, Such as Stock

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SALE OF CLAIMS:PURCHASER GOALS

Profit Motive◦Difference between anticipated dividend and purchase price

Gaining Control Over the Debtor

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SALE OF CLAIMS:MECHANICS

Claims are Typically Sold at a Discount

Claims Could be Sold Before or After Bankruptcy Filing

61


SALE OF CLAIMS:MECHANICS

Claims Sold During Bankruptcy Case Are Governed By Bankruptcy Rule 3001(e)◦If claim was sold before filing of proof of claim, buyer can file the proof of claim without court intervention

◦If claim was sold after filing of proof of claim, the following procedure applies: Buyer files evidence of sale with the

bankruptcy court Court clerk must give seller notice of the sale

and seller has 20 days to object to the sale If no timely objection, clerk notes sale on court

records

62


SALE OF CLAIMS: OFFER

Usually a Written Offer

Based on % of Claim

Investigate claims market for reasonable selling price

63


SALE OF CLAIMS:EVALUATING OFFER

Means to determine if there is a “higher and better” offer for the claim?

◦Check other prospective buyers for their price

◦Check bankruptcy case docket for relevant information

64


SALE OF CLAIMS:EVALUATING OFFER

Bankruptcy pleadings may disclose likely distribution on unsecured claims◦First Day Affirmation/Declaration◦DIP Financing Motion◦Schedules◦Asset Sale Motions◦Plan and Disclosure Statement

Notices of Sales of Claims – NOT likely

Check Debtor’s/Creditors’ Committee’s Websites

65


SALE OF CLAIMS:COMMITMENT LETTER/LETTER

OF INTENT Locks in Sale Price

DO NOT PERMIT THIS TO BECOME A CONTRACT

Sets Deadline for Seller to Finalize Sale, the Passage of Which, Without a Final Sale, Gives Buyer an Out◦ Make sure there is a similar deadline for seller

Otherwise - Risk of buyer locking in seller indefinitely

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SALE OF CLAIMS: ASSIGNMENT OF CLAIM AGREEMENT

Timing of Payment of Purchase Price

◦ Immediate payment of undisputed portion

◦ No reference to timing of payment could mean trouble!

◦ Payment conditioned on Buyer’s acceptance without time deadline could mean trouble!

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Amount of Price◦ % of undisputed/scheduled claim amount

Should be immediately payable◦ Treatment and payment of disputed portion of

claim following allowance Agreement to pay % of allowed claim amount Option to pay % when claims allowed NEVER

PERMIT THIS Is disputed portion of claim sold or retained by

seller?

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Representations by Seller Claim not disputed or subject to

defense, offset or counterclaim.

OR Disclose the disputed portion of claim

No preference risk

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Buyer Should be Obligated to Notify Seller of Objection to Claim and Seller Should be Given Ample Opportunity to Contest Objection

Buyer Should be Obligated to Notify Seller of Preference Action and Seller Should be Given Option to Defend Same

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Treatment of Preference Recovery Seller’s Obligation to Repurchase Claim in

the Event of Breach of Any Warranty/Representation or Other Breach of the Agreement ◦Interest usually charged from date of

execution of the agreement [should accrue from date of seller’s receipt of purchase price]

◦Interest rate could be very high◦Interest rate usually subject to

negotiation 71

Documents

WANDA BORGES, ESQ. BORGES & ASSOCIATES, LLC 575 UNDERHILL BLVD. SYOSSET, NY 11791 516-677-8200 x 225 [email protected] 0 TRMG - BUSINESS WITH A DEBTOR