Archive for the ‘Bankruptcy’ Category

The New, Streamlined Chapter 11 Bankruptcy Case — Part 2: Nine Significant Benefits of the Small Business Reorganization Act of 2019

In my last post, I discussed the new Small Business Reorganization Act of 2019 (“SBRA”), which will allow a small business debtor to reorganize in a streamlined chapter 11 bankruptcy case.  The SBRA offers the following benefits to the debtor:

 

  • Like a chapter 13 debtor, the SBRA debtor does not need to solicit votes from creditors to support its plan, which will reduce fees and aggravation.

 

  • Unless the bankruptcy court orders otherwise, the SBRA case will not have a creditors’ committee.  Because the debtor-in-bankruptcy is typically responsible for the fees of the creditors’ committee’s attorneys and accountants, as well as the debtor’s own professional fees, no committee means less expense for the debtor.

 

  • The bankruptcy court can confirm the SBRA plan over the objections of creditors provided that the plan does not “discriminate unfairly,” and is “fair and equitable,” with respect to each class of impaired claims or interests that have not accepted the plan.

 

  • The SBRA eliminates the “absolute priority rule” and permits a shareholder to retain ownership of the debtor business without the need to pay unsecured creditors more through the plan than the business’s projected disposable income (and the plan must not discriminate unfairly, and must be fair and equitable).

 

  • Like a chapter 13 trustee, the SBRA trustee would collect periodic payments from the debtor and make cash distributions to creditors, but cannot sell the debtor’s assets (in contrast, a chapter 7 trustee may sell the debtor’s non-exempt assets to pay creditors).

 

  • Unlike a chapter 13 plan, the SBRA plan can modify the rights of a creditor whose claim is secured only by the debtor’s primary residence, provided that the underlying loan was used primarily in connection with the debtor’s small business and not primarily to acquire that property.  This provision may allow the debtor to strip down a partially secured mortgage on his primary residence and discharge the balance of the loan.

 

  • “Means testing” under Bankruptcy Code section 707(b)(2) does not apply to the SBRA debtor.

 

  • In a typical chapter 11 case, administrative priority claims (such as trade debts or professional fees arising during a bankruptcy case) must be paid, in full, on the plan’s effective date.  In the SBRA case, an administrative claim can be paid over time through the plan.  This can help the cash-flow-challenged debtor to avoid a default on the first day of its reorganization.  In addition, the payment of an administrative claim through the plan may reduce payments to other creditors.

 

  • Unless the bankruptcy court orders otherwise, the SBRA debtor can avoid filing a disclosure statement, which will save it considerable time and professional fees.

 

As debtors’ attorneys discover the benefits of the SBRA, small business chapter 11 bankruptcy filings likely will increase.  As a result, creditors should prepare for this wave of filings, understand the limits of the SBRA and take steps to protect their interests.

Small Business Debtors Rejoice: The New, Streamlined Chapter 11 Bankruptcy Case – Part 1

For decades, members of Congress have claimed to be the saviors of small businesses.  At the same time, Congress created obstacles for those same businesses when seeking relief from their creditors.

Case in point: the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”).  BAPCPA added administrative hurdles for small businesses seeking to reorganize their finances.  In addition to the demands placed on big companies filing for bankruptcy, BAPCPA required small business debtors to file additional financial disclosures and to make an additional appearance.  Those extra demands placed considerable stress on small businesses already struggling with a diminished workforce and operational challenges.

Why did Congress make life so hard for small businesses?  Some in Congress believed that, because creditors would not invest the necessary resources to supervise the small business bankruptcy reorganization, Congress needed to implement “a variety of … enforcement mechanisms designed to weed out small business debtors who are not likely to reorganize.”  H.R. Rep. No. 109–31, at 19 (2005).  Inevitably, those enforcement tools destroyed small businesses that otherwise would have reorganized.  The collateral damage likely included lost jobs, vacant commercial space and frustrated customers, suppliers and landlords.

Fast forward to 2019.  Congress worked closely with bankruptcy experts and revamped the rules governing small business reorganizations.  The result was the Small Business Reorganization Act of 2019 (“SBRA”), codified in new subchapter V of chapter 11 of the Bankruptcy Code, which becomes effective in February 2020 and is available to business debtors with total debts up to $2,725,625.

The SBRA case borrows some features of a chapter 13 bankruptcy case.  As background, in a typical chapter 13 case, the debtor proposes a chapter 13 plan and makes monthly plan payments to the chapter 13 trustee.  If the chapter 13 plan commits all of the debtor’s disposable income for the plan’s 3 to 5 year term to pay unsecured creditors, the bankruptcy court can confirm the plan over the objections of creditors and the trustee.

In contrast, in a typical, non-SBRA chapter 11 bankruptcy case, the plan proponent (often, the debtor) must solicit votes from creditors to accept the chapter 11 plan.  The bankruptcy court cannot confirm a non-SBRA chapter 11 plan unless at least one class of impaired claims votes to accept the plan (an impaired claim is a claim that, under the plan, will not be satisfied in accordance with the contract terms).  Plan acceptance requires the affirmative vote of creditors holding at least two-thirds in dollar amount and more than one-half in number of allowed claims in that class.  Attorneys can spend many hours trying to gather votes from creditors, only to come up short when a creditor demands more, or does not return a telephone call, or is too large or too busy to keep track of balloting forms.

In my next post, I will share nine significant benefits that the SBRA offers to the small business debtor as an alternative to a traditional chapter 11 or chapter 13 case.

How to Prevent, or Deal With, a Preference Lawsuit

In my last article, I considered the possibility of a bankruptcy trustee suing to recover a “preferential transfer.” Preference lawsuits are very common in large bankruptcy cases, and reach many unsuspecting individuals and businesses. Here are a few strategies to help prevent (or deal with) a preference lawsuit:

1. Do not extend much credit to a customer before confirming its creditworthiness. Your due diligence may avoid a credit sale that otherwise could lead to a preference lawsuit (or the more obvious result: nonpayment).

2. Take and perfect a security interest in the goods that you sell. If you can be made whole by repossessing the goods, such that the payment will not improve your position, the payment may not be recoverable as a preference.

3. Determine if you have a defense, the most common of which being:

a. The “contemporaneous exchange” defense – e.g., a C.O.D. sale.

b. The “ordinary course of business” defense – did the debtor incur, in the ordinary course of its business, the debt for which the debtor made the payment, and either make the payment in the ordinary course of its and your business or financial affairs, or according to ordinary business terms? Said differently, was the debt, the payment and the surrounding events typical or unusual for all parties involved?

c. The “subsequent new value” defense – after the debtor made the payment to you, did you provide more goods or services?

(each defense may depend on other factors and require complex analyses not discussed here)

4. Seek a properly worded guaranty, and indemnification, from a third party capable of protecting your claim.

These strategies might not guarantee a favorable outcome, but they are a good starting point to protect yourself.

Being Preferred Is Not Always a Good Thing

What if, immediately after a customer pays you for a service you provided, the customer files for bankruptcy relief? You might consider yourself fortunate for not being one of the customer’s other creditors, who might have to wait years before they recover possibly pennies on the dollar.  But before you celebrate, take note: the bankruptcy estate could demand that you repay the money that the customer paid, even if there was no dispute concerning the quality of your services.

Why should you have to return any money?  Subject to certain exceptions, a bankruptcy trustee may seek to “avoid,” or recover, so-called “preferential transfers” if the debtor made payment to a creditor:

•   on account of a debt owed by the debtor before such transfer was made (such as a payment made on credit);

•   on or within 90 days before the filing of the bankruptcy;

•   while the debtor was insolvent (which is presumed during that 90-day period); and

•   enabling the creditor to receive more than the creditor would receive if the bankruptcy case were a liquidation, and if the payment had not otherwise been made.

The rationale behind a preference action is that a creditor should not be “preferred” over other creditors; by bringing into the bankruptcy estate the monies paid to preferred creditors, the funds can be redistributed to all creditors. This might sound fair, especially if a “preferred” creditor was paid ahead of other creditors only because it threatened the debtor’s business or harassed its employees with aggressive collection tactics. But not all creditors fit this mold. For example, a creditor may get paid quickly because it offers a discount for early payment, or is the only remaining supplier willing to sell to the debtor.

Either way, a preference lawsuit could spell disaster for a business if it must return a large preference payment.

Watch for my next article, in which I will discuss strategies to prevent, or favorably settle, a preference lawsuit.

When a Customer Files For Bankruptcy – Part 2

After reading my last article, you might wonder: what about the money owed for goods you sold more than 20 days before the bankruptcy filing? There still may be hope.

First, ask yourself:

• Did the customer receive the goods within 45 days before the bankruptcy? And,

• Did you sell the goods in the ordinary course of your business?

If you answer “yes” to these questions, you should make a written demand for “reclamation” (literally, you are demanding that the goods be returned). If you make this demand soon enough, and if another creditor does not already have a security interest in the goods, you may be entitled to payment for the goods before other, “unsecured” creditors receive anything.

Here is a possible scenario:
On each of June 1, June 21, July 1, and July 11, you sell, on credit, a box of parts to a manufacturer. Each box is worth $10,000. On July 21, you are owed $40,000, and the manufacturer files for bankruptcy.

Provided that you meet the necessary deadlines and substantiate the claim, you may seek payment of $20,000 (the value of the goods sold within 20 days before the bankruptcy filing) ahead of other, “unsecured” creditors.

You may make written demand for “reclamation” of the goods sold within 45 days before the bankruptcy filing, which consists of goods worth $30,000 (but if you recover $20,000 based on the above, this demand cannot recover more than the remaining $10,000).

And, what about the money owed for the goods you sold on June 1st? Unfortunately, you might have to wait with the rest of the “unsecured” creditors for this money. Actually, you could do better than that, but that is a topic for another article….

When a Customer Files For Bankruptcy – Part 1

If a customer files for bankruptcy, will you recover only pennies on the dollar, or, can you collect the full amount owed?  This question weighs on the minds of vendors and services providers when they receive that fateful notice, typically from the bankruptcy court, that a customer has filed for bankruptcy.  Now, let’s try to answer it.  First, ask yourself:

•    did you sell “goods” (rather than only services)?  And,

•    did the customer buy the goods from you in the ordinary course of the customer’s business?  And,

•    did the customer receive the goods within 20 days before the bankruptcy filing?

If you answer “yes” to these questions, and if you have not missed the deadline to file a proof of claim, you may be entitled to recover the entire value of the goods you sold.  If there is not enough money to pay your claim, you at least may be paid before other, “general unsecured” creditors.

The next time you receive a bankruptcy notice for a customer, just remember: you may be able to recover some or all of your claim.