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© Husch Blackwell LLP
Bankruptcy’s Impact On Your and Other Creditors’ Business:How to Make the Bad News Better
Ben Mann John Cruciani
© Husch Blackwell LLP
An Overview of Business Bankruptcy & Creditors’ Rights Issues
June 26, 2014 12-1pm CDT
Benjamin F. Mann Partner – Kansas City
John J. Cruciani Partner – Kansas City
© 2014 Husch Blackwell LLP. All Rights Reserved.
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)
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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 (§§ 1123-25) 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
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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
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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 Be Insolvent
Municipality Must Desire to put Together a Plan to Adjust its Debts
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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
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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 36-60 months)
Chapter 15 Ancillary Proceedings for non-US bankruptcy proceedings
for US assets
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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 362 -- The Automatic StayCreditors 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)
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Section 362 -- 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
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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
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Executory Contracts in Bankruptcy
• Not a termination – but an authorized breach
• Damages caused by breach – pre‐petition unsecured claim
Rejection:
(a/k/a Hell)
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
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Executory Contracts in Bankruptcy
No protection in bankruptcy law
But UCC § 2-609
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
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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
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§ 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 45‐21
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
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§ 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
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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 PreferenceA Transfer:
To or for the benefit of a creditor
For or on account of an “antecedent”
debt owed by debtor Transfer of debtor’s property
Made while debtor
is insolvent
Made within 90 days (1 year for
transfers to insiders) before bankruptcy filing
date
That enables the creditor to receive
more than if transfer had not occurred and there was a Chapter 7 liquidation of the
debtor
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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
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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
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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
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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
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How to Improve the Plight of the
Unsecured Creditor in Bankruptcy
1. Security Interest
2. Other Credit Enhancementsa. Guaranties
b. Letters of Credit
c. Mechanics (or other statutory) liens
3. Credit Insurance
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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
Disadvantages:
Existing blanket lienholder has negative pledge
Second lien position may have no value
Delays in filing can create preferences
Advantages / Disadvantages in Bankruptcy for Secured Creditor
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Other Credit Enhancements
1. Guaranty by Third PartyAdvantage: Not subject to automatic stay
Disadvantage: Still subject to collection risks and costs
2. Letter of CreditAdvantage: Not subject to automatic stay
Virtually no collection risks or costs
Disadvantage: Debtor reluctant to give because it costs money
3. Mechanics and Other Statutory LiensKey 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
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Credit Insurance
Two major types of insurance Insurance for some or all of your A/R portfolio
Insurance specific to a certain customer
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
Credit Insurance
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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
Credit Insurance
Non-Bankruptcy Proceedings
Receiverships ABCsState Law Insolvency Proceedings
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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.
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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
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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
Sole Source Suppliers
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
Tooling/Dies/Goods in Possession of our Customers
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Tolling/Dies/Goods in Possession of our Customers
UCC 9-505 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
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
Tolling/Dies/Goods in Possession of our Customers
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Questions?
John CrucianiPartner
Kansas City, MO
816.983.8197
Ben MannPartner
Kansas City, MO
816.983.8126
Thank You!