Fall 2005 • Issue 19, page 1

What is the sudden impact of the Revised Bankruptcy code on Business Reorganizations

By Shulman, Leonard & Huttenhoff, Robert*

The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” (hereinafter the “Act”) was enacted primarily to prevent perceived consumer bankruptcy case abuses (i.e. personal Chapter 7 cases involving consumer debt). Numerous changes also dramatically impact business reorganizations, however. The Act became effective on October 17, 2005 and most changes apply only to cases filed on or after that date. Some of the more significant changes affecting business reorganizations are described below.

Chapter 11 Plan Exclusivity Under the Revised Code
“Plan exclusivity” is that period in a Chapter 11 case during which the debtor has an “exclusive right to file a plan of reorganization,” according to Bankruptcy Code Section 1121. Congress has now significantly limited the “exclusivity period.” Under both the old and new provisions “only a debtor may file a plan until after 120 days after the date of the order for relief under this chapter.” Both the old and new provisions also allow the debtor 180 days for confirmation of a plan. Under the old provisions, however, a debtor could request and almost routinely be granted extensions of these limitation periods.

Amended section 1121(d) now caps the exclusivity period for filing a disclosure statement at 18 months, and for confirming a plan at 20 months. Debtors will no longer be able to indefinitely delay negotiating a proposed plan with creditors and will need to proceed quickly towards an exit strategy.

Assumption of Non-Residential Leases Under the Revised Code
Under prior law, the debtor’s unexpired lease of nonresidential real property was deemed rejected if the debtor did not formally assume the lease within 60 days after the petition date. But the bankruptcy court retained authority to grant multiple extensions of this time for assumption or rejection, and routinely did so.

Under revised section 365(d)(4), a debtor/lessee must assume or reject a lease before the earlier of 120 days after the date of the order for relief or the date of entry of an order confirming a plan. A debtor (or trustee or landlord) may seek an extension for cause for up to a maximum of an additional 90 days for cause. Further extensions will be available only with the “prior written consent of the lessor.” 11 U.S.C. §365(d)(4)(B)(ii). Thus, absent the landlord’s consent, the debtor or trustee must decide to assume or reject the lease no later than a maximum of 210 days after the date of the order for relief.

The Act also caps the damages a landlord may seek when a lease is assumed by a debtor or trustee and later rejected. The current law provides that the entire amount of the lease payments owed on an assumed lease is entitled to an administrative priority claim. Under new section 503(b)(7), the administrative claim for such an assumed (and later rejected) lease is capped at two years worth of lease payments from the date of rejection.

New Section 365(b)(1)(A)—one of the few provisions of the Act benefiting the debtor—allows a debtor to assume an unexpired lease of real property without having to cure defaults of non-monetary obligations/acts. Under current law a debtor cannot assume a lease if there has been a non-monetary default that can’t be cured. For example, violation of a contractual “going dark” provision, where a debtor fails to continuously operate the business, works a default. Lessors often close stores prior to filing bankruptcy, violating these provisions. The Code revision allows a debtor to assume such a lease provided the debtor is not in default at or after the time of assumption and compensates the lessor for any actual economic loss sustained as a result of the default. This allows a debtor to reinstate a valuable lease that would otherwise be lost.

Tax Provisions Affecting Business Reorganizations
The Act contains new provisions regarding the payment of tax claims. Under prior law a debtor could pay the allowed unsecured claims of governmental units with deferred cash payments over a period not exceeding 6 years from the date of assessment. The Act’s revisions significantly limit the time period for these payments – which must now be paid in full within 5 years after the date of the entry of order for relief.

The revised Code also requires a debtor to pay the taxing authority in a manner no less favorable than treatment accorded holders of other non-priority unsecured claims. There are other tax provisions in the revised Code that made it compelling for a business debtor to seek to reorganize prior to the October 17, 2005 effective date of the Act.

Priority Wage Claims Under the Revised Code
Section 507 of the Bankruptcy Code addresses the priority wage claims for company employees – which are typically paid shortly after the case is commenced. Present law caps priority employee wages, salaries or commissions and benefits at $4,925.00 per employee and limits them to those earned within 90 days before the petition date. The Act revises this, increasing the cap on priority wage claims to $10,000.00, and extending the time of accrual to 180 days before the filing. This will significantly increase the “priority” obligations owed by a debtor to its employees.

Utilities and Adequate Assurances Under the Revised Code
Revised Section 366 requires a debtor to provide adequate assurances of payment to utilities in the form of a cash deposit, letter of credit, certificate of deposit, surety bond, prepayment, or other form mutually agreed upon by the utility and the debtor. Prior to this revision, a debtor could simply offer the utility an administrative expense priority to keep utilities turned on. Under the Act’s new terms, the court may not consider the debtor’s timely pre-petition payments, or the availability of an administrative expense claim in determining what constitutes adequate assurance. The debtor is allowed 30 days, rather than the current 20 days, to provide the assurance, however.

Vendors Reclamation Rights Under the Revised Code
The Act enhances vendors’ reclamation rights: Section 546 grants a federal right of reclamation in favor of a seller of goods received by the debtor within 45 days before the commencement of the case, rather than the 10 or 20 days under current law. The seller must demand reclamation within 45 days after delivering the goods or within 20 days after the filing of the case if the 45-day period would have expired subsequent to the filing. This amendment also deletes a provision allowing the court to deny reclamation if it grants an administrative expense claim to the reclaiming creditor.
Revised section 546 also clarifies that the reclamation right is subject to the rights of secured creditors. In a separate win for trade vendors, a change to section 503 accords an administrative expense claim for the value of goods delivered to the debtor during the last 20 days before the filing, whether or not the vendor demands reclamation.

New Provisions Affecting “Small Business Debtors”
(70% of Chapter 11 filers fall within the Code’s new definition of “Small Business Debtor”—Ed.) The revised Bankruptcy Code contains several provisions that apply exclusively to “small business debtors,” the definition of which is revised to generally include any entity engaged in commercial or business activity that has less than $2,000,000.00 in total non-contingent liquidated unsecured and secured debts. The definition also excludes debtors in cases in which an active committee of unsecured creditors has been appointed.

Before the amendments, whether to elect the small business debtor treatment was left to the option of debtor. The revised statute requires that a debtor falling within the definition of a small business debtor must comply with new, special requirements.

The “exclusivity period” for small business debtors is slightly modified. For such businesses, the revised Code provides the debtor a 160-day exclusivity period after the order for relief and an absolute plan-filing deadline of 300 days after the order for relief. These deadlines may be extended by the court if a debtor can establish that it is likely to confirm a plan within a reasonable period of time.

Additionally, the revised Section 1116 requires (among other things) that a small business debtor must file with the Court its most recent balance sheet, statement of operations, cash-flow statements and federal tax returns within 7 days after the commencement of its case.

*LEONARD M. SHULMAN is the managing partner of Shulman Hodges & Bastian LLP. Mr. Shulman’s practice concentrates in the area of commercial transactions and bankruptcy law.

*ROBERT E. HUTTENHOFF is an associate of Shulman Hodges & Bastian LLP. Mr. Huttenhoff’s practice concentrates in the area of business litigation and bankruptcy law.