Considering the Business End to Bankruptcy Changes



As published in the Nashville Business Journal.

On Oct. 17, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 became effective. Although the most notable aspects of these amendments relate to consumer Chapter 7 and 13 bankruptcy cases, important changes also were made that affect businesses in Chapter 11.

The amendments to Chapter 11 for business debtors followed many of the recommendations contained within the report of the National Bankruptcy Review Commission (NBRC) issued in 1998. These recommendations were made after several years of debate, particularly in relation to the amendments relating to small businesses (debtors with less than $2 million in secured and unsecured debt).

The NBRC had concluded that the most common abuse in Chapter 11 cases existed with small businesses, and thus the amendments required such businesses to provide more information to creditors and impose deadlines for the businesses to either reorganize or face liquidation.

In addition to placing limits on small businesses, one of the clear purposes of the 2005 amendments was to reduce the discretion that bankruptcy judges have in extending deadlines under the bankruptcy code. This will have the effect of forcing larger Chapter 11 cases to accelerate their reorganization, in some cases to the detriment of general unsecured creditors. For example, the deadline for a debtor to assume or reject a non-residential real property lease has been reduced. The prior statute imposed a 60-day deadline for the debtor to assume or reject such leases, but also provided the bankruptcy court unlimited discretion in extending this deadline.

This discretion has been frequently exercised, particularly in retail cases with a large number of long-term commercial leases. Additional time often was needed by the debtors to determine which locations were important to the reorganization, and thus extensions often were supported by the unsecured creditors because it enabled the debtor to delay having to spend valuable capital incurring defaults and incurring long-term, post-petition administrative expenses that have priority over unsecured debts.

On the other hand, such extensions created uncertainty for the landlords, making it difficult for commercial properties either to be sold or refinanced. The 2005 Amendments reduced the court's discretion by placing an absolute seven-month cap on the period that a debtor has to assume or reject non-residential real property leases.

Additionally, court discretion was taken away for extending the deadlines established for a debtor to file a plan of reorganization. Under the prior statute, the debtor had an exclusive period to file a plan within 120 days after the commencement of the case.

Like the real estate leases, this deadline was subject to unlimited extensions to the extent the court deemed sufficient cause had been established. The new law sets a maximum limit of 18 months on the debtor's exclusive right to file a plan.

This limitation will have its greatest impact on large Chapter 11 cases because a 18 months is typically plenty of time for a smaller debtor to reorganize. Furthermore, the expiration of the deadline doesn't eliminate the debtor's ability to file a plan of reorganization at a later date; it only eliminates the debtor's exclusive right to file a plan.

Thus the earlier deadline will enable creditors to propose their own competing plan of reorganization. This competition can be beneficial in forcing the debtor to move a case along. The maximum filing period for small business debtors was reduced even more, down to 10 months.

Another area of discretion removed from the courts was the discretion previously given on motions to dismiss a bankruptcy case or convert that case to another chapter under the bankruptcy code. The amendments imposed a mandatory dismissal or conversion if the court finds that the debtor failed to comply with the 10 non-exclusive grounds for dismissal included within the Code.

Such grounds include the debtor's failure to maintain insurance, unauthorized use of cash collateral, failure to satisfy any filing or reporting requirement, failure to provide any information reasonably requested by the U.S. Trustee, and failure to pay any taxes due post-petition. In the past, courts had discretion to evaluate whether such breaches were material or in the best interest of the estate.

The removal of discretion from the bankruptcy judges will have the effect of upsetting the balance that previously existed between debtors, creditors and the court. This balance encouraged negotiated settlements and gave the courts the flexibility to act in the best interest of the estate.

Of the vast changes made by the 2005 amendments, the provisions affecting business reorganizations were the least obtrusive to the existing process.

Although there has been a rush by some debtors to file before the Oct. 17 effective date, the impact on future Chapter 11 businesses will not be near as great as the impact that the 2005 amendments will have on consumer debtors. Creditors may have more leverage than before, but the Chapter 11 practice will remain substantially the same.