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By Diane Davis
Oct. 8 — The tension between rehabilitation versus liquidation of companies in Chapter 11 bankruptcy is still “alive and well” 10 years after Congress made the most sweeping changes to the Bankruptcy Code since 1978, according to bankruptcy experts speaking at an American Bankruptcy Institute webinar Oct. 8.
Many of those changes to the Bankruptcy Code had an “unintended impact,” the panelists said.
The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 contained significant “creditor friendly” changes to the Bankruptcy Code primarily because various groups representing creditors pushed for better treatment than under the 1978 Code, according to Robert J. Keach, a shareholder at Bernstein, Shur, Sawyer & Nelson, Portland, Maine, and co-chair of the ABI's Commission to study the reform of Chapter 11.
Some of these “creditor friendly” changes included shortening the deadlines or time frames for assuming or rejecting leases, reducing judicial discretion, and enhancing exclusions of certain transactions.
Creditors were seeking shorter time periods, according to Richard Levin, a member of Jenner & Block's Bankruptcy, Workout and Corporate Reorganization Practice in New York. They also wanted to remove judicial discretion with respect to those time periods, he said.
These changes had a “very little effect on the credit markets for distressed companies,” Keach said. The Bankruptcy Code changes actually had unintended consequences, according to Keach. Creditors are less willing to lend for longer time periods, he said.
Lending groups argued that BAPCPA's changes support lending, Levin said, but it's basically like a “zero-sum game” where you take away from one group and give it to another.
“It's hard to say whether BAPCPA affected the price of credit overall,” Levin said.
An unintended impact of BAPCPA is in the area of large retail Chapter 11 cases, where it essentially “eliminated an opportunity for retailers that could be saved to be saved,” Keach said.
Prior to BAPCPA, debtors had 60 days to assume or reject a lease, but that time period could be extended. That gave debtors time to sort through all of the leases and review them adequately, but it did create a lot of uncertainty in the marketplace, Keach said.
Under BAPCPA, the whole process is capped at 210 days, which means that a debtor company may not have time to operate through an entire business cycle, Keach said. This makes it hard to restructure, he said.
Lenders started to put on pressure at the same time to liquidate, Keach said. As a result, lenders started creating milestones for debtors to make, which in effect turned most retail bankruptcy cases into sales, not restructurings, he said.
Panel moderator Michelle Harner, professor of law and the director of the business law program at the University of Maryland Francis King Carey School of Law, Baltimore, noted that these time periods can still be extended with consent. Harner is also the ABI Resident Scholar for the Fall 2015 semester, and was the Reporter for the ABI Commission to study the reform of Chapter 11.
Getting consent is “complicated,” according to Levin. It is somewhat unpredictable to get a landlords' consent, he said.
“At that point, it is probably too late,” Keach said.
Then “why do retailers keep filing bankruptcy?” Harner asked.
Retailers keep filing Chapter 11 to sell, Keach said. Most retailers who have filed Chapter 11 in the last 10 years sold the business, he said. They used the bankruptcy system rather than state foreclosures in multiple states as a “quicker and more unified foreclosure devise,” Keach explained.
Harner noted that the ABI Commission's final report released Dec. 8, 2014, on the reform of Chapter 11 recommended some changes in many areas including leases, Bankruptcy Code Section 363 sales, and small business bankruptcy cases. The ABI commission's full report is available for download at: http://commission.abi.org/ .
According to Keach, the ABI commission's report recommended extending the maximum amount of time for the lease process to 365 days, rather than 210 days.
“It's a balancing act,” Keach said. “Landlords need some certainty, but debtors need to go through an entire business cycle,” he said.
In the area of Section 363 sales, the ABI Commission's proposal wanted to slow down the process to be able to determine if a sale is warranted and to get the best price for the debtor company, Keach said. The ABI Commission proposes no sales within the first 60 days of a case, he said.
Keach said another proposal by the ABI Commission would affect small business bankruptcies. Under BAPCPA, there was an “unfortunate presumption that small companies are simple and have simple organizations and problems, Keach said. As a result, BAPCPA made strict requirements for small businesses, which most companies failed, he said.
Companies in bankruptcy had “no opportunity for success,” and bankruptcy didn't solve the companies' structural problems, Keach said.
Under the ABI Commission's proposal, the accepting and impaired class requirement under the Bankruptcy Code would be eliminated so that more companies “can be saved and remove the structural barriers,” Keach said.
Companies in bankruptcy “have to have the tools to rehabilitate under the Bankruptcy Code,” Harner said.
A “fair restructuring system will have an impact on entrepreneurism,” Keach said.
Even having a “going concern sale where a company's assets and people get preserved” in a company sale situation is a good function,” Levin said.
BAPCPA also unintentionally “fostered prepacks,” where a debtor company plans all of its support agreements in advance before ever filing for Chapter 11, Keach said. “A lot of restructuring work is done pre-filing,” he said.
“People have learned the system and know what to do to get to the end faster,” Levin said.
Harner pointed to recent studies showing that many prepacks lead to refilings.
“People have learned how to do prepacks,” Levin said. Companies focus on the balance sheet and not on the operational aspects of the bankruptcy the first time, he said.
Keach agreed, saying that debtors focus on fixing the balance sheet first and making changes with the attitude that “if it works, it works, but if not, the company will refile.”
Both Keach and Levin agreed that BAPCPA changes didn't drive the number of Chapter 11 bankruptcy filings down.
“It's hard to attribute the drop in filings to BAPCPA,” Levin said. “The economy is the real driver,” he said.
“Its a completely different universe than it was in 1978, or even in 2005,” Keach pointed out. Companies are “more leveraged than before,” he said.
Some of BAPCPA's changes in the area of executive compensation and Key Employee Retention Plans (KERPs) were too broad, Keach said.
BAPCPA changes to KERPs were not motivated by creditor pressure, Levin said, but by political outrage at excessive compensation for executives. According to Levin, BAPCPA “cut way back” on executive compensation to the point that the senior executives's formula was almost impossible to satisfy in bankruptcy. KERPs were essentially limited, he said.
Lawyers found a way around BAPCPA's changes by drafting key incentive plans, Levin said. The question, he said, is always whether these plans are “disguised KERPs”?
Courts have been vigilant in making sure that key incentive plans aren't just disguised retention programs, Levin said.
“BAPCPA essentially banned KERPs rather than leaving it to judicial discretion,” Keach said.
Recent cases involving this issue show that bankruptcy judges can sort this out because BAPCPA's changes were too broad, Keach said.
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