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Bankruptcy Reform Amendments: Changes to Affect Corporate and Commercial Cases

May 31, 2005

By Paul Hastings Professional

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 which amends the United States Bankruptcy Code. While most of the amendments address perceived abuses in consumer bankruptcy cases, there are a number of amendments which will impact corporate and commercial cases.  The more significant amendments to business bankruptcy cases are summarized below, with these changes described in greater detail in the outline attached hereto.

Amendments

Disinterestedness (Sec. 101(14)) investment bankers which worked for a debtor pre-petition with respect to any security issued pre-petition will no longer be per se disqualified based upon their pre-petition role and may now be retained post-petition subject to satisfying the other disinterestedness standards.
Forward contract, master netting, repurchase and swap agreements (Sec. 101(25), (38A), (47) and (53B)) new or expanded definitions to address and clarify rights of a counter party to terminate, liquidate or accelerate and close out of forward contracts, swaps, repos and netting agreements.

Single asset real estate (Sec. 101(51B)) removes dollar cap on aggregate noncontingent, liquidated secured debts for application of special relief from stay provisions to single asset real estate cases.

Status conferences (Sec. 105) mandatory if requested by any party-in-interest.

Involuntary case (Sec. 303) a petitioning creditor must hold a claim subject to a bona fide dispute as to liability or amount.

Foreign proceedings (Sec. 304) former Section 304 addressing U.S. bankruptcy cases  ancillary to foreign proceedings has been deleted; a new Chapter 15 has been enacted and addresses cross-border cases exclusively.

Prepackaged Ch. 11s (Sec. 341) the court may dispense with first meeting of creditors in connection with a prepackaged plan.

Notices (Sec. 342) notice sections of the Bankruptcy Code have been substantially modified and set forth specific requirements for notices; non-conforming notices will not be effective.

Automatic stay (Sec. 362) contains additional new exceptions to imposition of automatic stay (e.g., specifically excepting from stay, investigations and actions by a security self regulatory organization and actions to delist a debtors stock).  Amendments also clarify that swaps, repos, forward and similar contracts can be closed out upon a bankruptcy filing without violating the automatic stay.

Leases (Sec. 365) two major modifications: (i) debtor need not cure non-monetary defaults under expired leases of non residential real property to assume those leases, but will need to compensate landlords for loss resulting from the impossibility to cure; and (ii) a debtor has to determine upon the earlier of 120 days after the petition filing or the date of confirmation whether to assume or reject non-residential leases of real property.  The court may extend the 120 day period, but up to only a maximum of 90 additional days, thus providing for a maximum of 210 days for a debtor to assume or reject leases of non-residential real property.

Administrative expenses (Sec. 503) major modifications include: (i) increase from one to two years the maximum claim under an assumed non-residential real property lease that is subsequently rejected with the remaining amounts capped under Sec. 502(b)(6); (ii) an allowed administrative expense claim for the value of goods delivered to the debtor during the last 20 days before the bankruptcy filing; and (iii) significant restrictions on key employee retention plans.  As to the latter, for example, a debtor may not pay or agree to pay any amount to induce a person to remain in a debtors employ unless specific requirements are met, such as showing that the person has a bona fide job offer from another entity and the services of the person must be essential to the survival of the business.  If these two requirements are met the amount allowed under any KERP is then further restricted in dollar amounts.

State ad valorem tax (Sec. 506(c)) amendment provides that a trustee or debtor may recover from property securing a claim all unpaid ad valorem property taxes with respect to the property.
Priority wage claims (Sec. 507) amount of cap of priority wage claims is increased to $10,000 and time for accrual is extended from 90 days to 180 days before a bankruptcy filing.  There is a corresponding change to employee benefit claims.

Reclamation claims (Sec. 546) subject to prior rights of a holder of a security interest in goods or proceeds thereof, reclamation claims are expanded from a period of 20 days to 45 days prior to the bankruptcy filing.  Any reclamation claim for goods delivered within 20 days of the filing which is not paid is deemed to be an administrative expense claim to the reclaiming creditor.

Preferences (Sec. 547) amendments expand the ordinary course of business defenses in a manner favorable to defendants (e.g., look at either ordinary course between debtor and vendor, or ordinary course in industry) and prohibits actions for transfers of less than $5,000.

Fraudulent transfers (Sec. 548) expands reach back period from one year to two years prior to the bankruptcy filing.  [Note:  this amendment applies only to cases filed on or after April 20, 2006]
Forward contract, securities contract, swaps, repo and master netting agreements (Sec.s 555, 556, 559, 560, 561 and 562) these sections have been significantly amended to allow and clarify termination of netting of commodities, forward and securities contracts and repurchase, swaps and master netting agreements when one of the parties enters bankruptcy.  There are corresponding amendments throughout the Bankruptcy Code and federal banking laws.  Section 562 specifically provides that the measurement of damages shall be on the earlier of the date of the rejection of the contract or the date or dates of liquidation, termination or acceleration.

Appointment of a Trustee (Sec. 1104) - requires the U.S. trustee to move for the appointment of a trustee if reasonable grounds exist to suspect that current management of the debtor participated in actual fraud, dishonesty, or criminal conduct in the management of the debtor or the debtors public financial reporting.  [Note this amendment applies immediately to any case filed after April 20, 2005]

Conversion/dismissal (Sec. 1112) what constitutes cause for conversion/dismissal of a Chapter 11 case has been expanded from 10 to 16 enumerated acts (e.g., including failure to maintain insurance, unauthorized use of cash collateral, failure to timely provide information).

Exclusivity (Sec. 1121) expansion of exclusivity period following filing of Chapter 11 case is limited to a maximum of 18 months to file a plan and 20 months to obtain acceptances, with no further extensions of exclusivity thereafter allowed.

Treatment of priority tax claims (Sec. 1129) treatment of priority tax claims modified to require regular installment payments in a payout over five years from the date of the bankruptcy petition (rather than six years from the date of assessment).

Exceptions to Corporate Discharge (Sec. 1141(6)) new provision which excludes from discharge certain fraud claims and tax / custom duty claims.

Venue for avoidance actions (28 USC §1409) venue for proceedings to recover debts of less than $10,000 from a non-insider are restricted to the defendants district of residence rather than the district where the bankruptcy case is pending.

Looking Forward

Globally, the amendments reflect a convergence of bankruptcy and insolvency laws internationally.  The United States seems to be moving closer to a model that anticipates strict time limits and earlier liquidation scenarios while the rest of the world is experimenting with and implementing reorganization alternatives that preserve going concern value.  The result is an increasing convergence or "meeting in the middle" of insolvency laws around the globe.  In addition, the broad protections afforded to financial contracts, including various derivatives, hedging obligations and swaps, are consistent with the manner in which contemporary "borrowers without borders" conduct their financial affairs.

There is an effort to curb perceived abuses by debtors and their management. There are now substantial restrictions on key employee retention and severance payments,  restrictions on exclusivity, a longer line of creditors who must be paid as the price of a chapter 11 (utilities, sellers of goods delivered within 20 days of the filing, employees, landlords, warehousemen), the express exclusion from property of the estate of deductions from payroll, the requirement that a debtor or the trustee has to continue to administer employee benefit plans and, for the first time, nondischargeable debts for corporations (though limited to certain fraud and tax claims).  The increased demands upon a chapter 11 debtor's liquidity are likely to make reorganization more expensive and more difficult.

From the perspective of case administration, there is more oversight and less discretion for the courts and committees.  The amendments limit discretion and flexibility in significant ways: (a) there are a number of "thou shalt nots" which now require the conversion or dismissal of a case or the appointment of a trustee, (b) there is a move to absolute statutory restrictions rather than allowing flexibility to the courts for "cause" or upon an adequate showing (limits on exclusivity, time to assume or reject leases, utility deposits, expansion of single asset real estate cases and eliminating the optionality of small business cases), (c)  committees  are now required to share information with and solicit input from their constituencies, and (d) the Code now mandates the appointment of an "ombudsperson" in designated areas (consumer privacy, healthcare).  These provisions, together with the special interest legislative provisions, restrict the flexibility that has been a hallmark of chapter 11 reorganizations.
From the perspective of a secured creditor, there is very good news on the consumer front and mostly neutral or good news on commercial loans, except to the extent that reorganization value will prove more difficult to realize on enterprise value loans.  The consumer provisions adopt a "means" test for chapter 7 eligibility based upon income and ability to repay and provide that an individual is not entitled to a chapter 11 discharge until after all plan payments are made.  Secured commercial lenders have the benefit of (a) an extension of the "safe harbor" relation back for the perfection of security interests from 10 to 30 days, (b) an easing of the previously difficult "ordinary course" defense to preference actions, and (c) the exemption of all manner of repurchase agreements, swaps, securities contracts (including margin loans), netting arrangements, and other financial contracts from the automatic stay and from the avoidance provisions of the bankruptcy code.

If you have any questions regarding the recent amendments to the Bankruptcy Code, please contact the following Paul Hastings attorneys:

Jesse H. Austin, III 404 815 2208

Karol K. Denniston 404 815 2347

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karolkdenniston@paulhastings.com

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Hydee Feldstein 213 683 6100

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hydeefeldstein@paulhastings.com

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Leslie A. Plaskon 212 318 6421

Kristine M. Shryock 212 318 6961

The Paul Hastings Finance and Restructuring Group consists of more 60 attorneys in Atlanta, Hong Kong, London, Los Angeles, Milan, New York, Paris, Stamford, Tokyo and Washington, D.C. The group is able to serve the legal needs of lenders at every stage of a loan's lifecycle. In 2004, FRG participated in deals valued at more than $22 billion, and many of these deals involved complex transactions across multiple jurisdictions and practice areas. Recently, the group ranked 3rd among law firms in overall leveraged loans by number of deals in the Loan Pricing Corporation Gold Sheets league tables for 2004.

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