Posted on May 9, 2009 by Teri Rasmussen

Alas,Bankruptcy Law, We Knew Ye Well - Consequences of Chrysler's 363 Sale

They say that "hard cases make bad law".  And that's never been more true than in the current Chrysler (and soon to follow, GM) bankruptcy.  In the practice of bankruptcy law, we really do talk a lot about what's "fair and equitable".  And having a transaction as complex as that proposed by Chrysler -- or at least the bidding procedures designed to make any other alternative near impossible -- approved in a matter of days seems to me to turn this fundamental underlying value of bankruptcy law and practice on its head.

When I started law school, I had no idea I would become a creditor-oriented bankruptcy lawyer in Central Ohio.  Having now been one for more years than a lady cares to count, I've always felt that bankruptcy law was relatively internally consistent in comparison with other areas of law.  And it seemed to make sense and strike a balance between debtors and their creditors.  Up to now, once you understood the basic fundamental principles, concepts, and underlying values of bankruptcy law and practice, you could often reason your way to what the applicable rule would be even if you couldn't remember the exact statutory provisions.  And that has always seemed good to me. 

Now, in the name of a perceived (and perhaps, even actual) urgency and expediency, the Chrysler (and soon to be GM) bankruptcy are perverting and destroying that unifying fabric of bankruptcy law.  Others have posted on some of the damage being done, most notably Steve Jakubowski of The Bankruptcy Litigation Blog who asks "Will the 'Absolute Priority Rule' Kill the Sale?" and thoughtfully analyzes (and has deservedly received a lot of notice for his post) whether the Chrysler sale is "Testing the Limits of Section 363 Sales"

For me, it is the desecretion of the process of achieving "confirmation" of a "plan of reorganization" that bothers me the most.  Instead of requiring this process to play out, Judge Gonzalez appears to be allowing Chrysler to bypass it entirely, thereby corrupting the entire "363 sale" procedure. The"preliminary sale order", and especially the "Bidding Procedures" it approves, are tantamount to a"plan of reorganization", but alleviate Chrysler's need to comply with certain  procedures required in that situation.

Why is this bad?  Because it essentially wipes out the whole plan confirmation process.  I am sure there will be an effort to say that this (and perhaps GM as well if it also goes this route) present unique and special circumstances.  And they probably do.  However, any business bankruptcy debtor attorney worth his or her salt will now emphatically assert  -- as Chrysler's lawyers have -- that there is simply no time to follow the lengthier statutory plan confirmation procedures and that the value of the business is drastically depreciating with every day's delay.  They will also insist  -- as Chrysler's lawyers have -- that nothing will do but to require any bidders to mark up their proposed Purchase Agreement.  It might also encourage to wait to file until it absolutely positively IS that sort of emergency situation.   

And perhaps the most tantalizing of all Chrysler's arguments is that bankruptcy is all about the debtor and should be interpreted in whatever way is most likely to keep the debtor from having to liquidate --

in a business reorganization case, among all the other policies served by specific provisions of the Bankruptcy Code, this fundamental objective of preserving the debtor's businss as a going concern is paramount.

Now that's a principal every debtor can get behind and use to justify almost anything.   

>>>> How often debtors succeed with these arguments and tactics will make a big difference in the Chapter 11 bankruptcy process for years to come.

Once upon a time, a 363 sale was reserved for disposing of certain selected assets.  As time went on, it became more common to also use it when selling all of the assets of a company.  But it was still mostly, if not entirely, the SALE OF ASSETS,  No assumption of leases and contracts or other fancy stuff.

If a debtor wanted to load up a proposed 363 sale with all sorts of bells and whistles -- as Chrysler has -- it had to file a proposed "Plan of Reorganization", accompanied by a "Disclosure Statement", instead, explaining how the plan for exiting bankruptcy would work.  Section 1123 of the Bankruptcy Code sets forth what the plan must contain.  Section 1125 requires the Disclosure Statement  to provide "adequate information" about a plan and its implementation and consequences such that a hypothetical investor would be able "to make an informed judgment about the plan".    

Once a proposed plan and Disclosure Statement are filed,  Bankruptcy Rule 3017 requires at least 25 days notice of a hearing to determine if the Disclosure Statement is satisfactory. If it is, the plan and Disclosure Statement are circulated to all creditors who then have an opportunity to vote on the plan.  For each "class", i.e. grouping, section 1126 requires that creditors holding more than half of the claims in number and at least two-thirds in amount must vote to "accept" the plan.  Another 25 days must go by before the "confirmation" hearing can be held.  When that day comes, the debtor must deal with any objections to the plan such questions about feasibility and meet the requirements of section 1129 of the Bankruptcy Code. in order to have the plan successfully "confirmed".

Is that a lot of work?  You bet!  And it's one reason so-called prepackaged bankruptcies (prepacks to those in the biz) became popular as a way to at least cut down on the amount of time. 

But what it also does is give those who would be most affected by the debtor's bankruptcy exit plan time and information to evaluate the course advocated by the debtor.  It also requires a fairly broad base of support for the debtor's proposal.  Unlike a 363 sale in which an 800 pound gorilla like Chrysler and its high powered attorneys can quite literally steamroll over smaller and in this case perhaps not entirely organized yet creditors, the plan confirmation process recognizes and allows these parties more of a chance to participate.  Granted, they may still be largely ignored, but at least collectively they do have at least some voice. 

It's possible that the sale might still be rejected on these sorts of grounds -- technically a hearing on the Sale Motion itself doesn't occur until May 27 -- but it seems a little silly to allow bidding to move forward only to reject the product of those activites.

American law and society have always recognized the importance of individuals and have many safeguards to protect individual rights.  What I fear most is that the legacy of the Chrysler/GM bankruptcies will be a bankruptcy process left in tatters.  And somehow less "fair"

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Posted on March 7, 2009 by Teri Rasmussen

The Long and Winding Road of Chapter 11 Bankruptcy: A Typical Timeline

I'm not sure how good I feel about the fact that far too many people now actually understand what I do as a bankruptcy creditors' attorney here in Central Ohio.  If I was unsure before about the truly distressing condition of the economy, the car ad I saw on TV the other day - which sought to induce viewers to purchase a car by telling them that  if they lost their source of income over the next year, they would be able to bring the car back - removed all doubt.  Then I heard this morning that the unemployment rate is the highest it has been in TWENTY-FIVE YEARS, which is to say AS LONG AS I'VE BEEN WORKING!!   Which certainily puts things in perspective and leads to the further disturbing conclusion that for lawyers like me working for creditors in the bankruptcy law area, job security is probably somewhat better than for the rest of America.

Unfortunately, for the country as a whole, the number of businesses becoming familar with the mechanics of Chapter 11 of the Bankruptcy Code is likely to increase in the year ahead.  Either one of their customers or vendors will be going through this or they themselves will become a Chapter 11 debtor-in-possession or DIP, for short.   

In addition, there has been a great deal of discussion recently about prepackaged bankruptcy for Detroit's Big Three automakers as being a possible antidote to the problems associated with the lengthy time frames associated with the the usual Chapter 11 bankruptcy,  To understand that, it's useful to consider the timelines generally associated with a Chapter 11 bankruptcy proceeding.

OVERVIEW OF EFFECT OF CHAPTER 11 FILING

So what actually happens when a business "goes Chapter 11"?  In many cases, those not in the know about the particular financial condition of a business may not even know that the business has sought the protection of the federal bankruptcy laws.  Companies in Chapter 11 bankruptcy are allowed to continue operating their business as before and from the customer perspective, the filing of the bankruptcy does not necessarily change the customer experience.  However, it is the bankrupt company's vendors and suppliers  that will notice an immediate difference in their relationships as various restrictions imposed by the Bankruptcy Code on the activities of the debtor company come into play. 

Technically, everything grinds to a halt when a bankruptcy petiton is filed and the world - for that company (who has now become a Debtor-in-Possession or DIP), its employees, customers, and vendors - was now become divided into

  • "prepetition" involving claims arising and events occurring BEFORE the bankruptcy petition was filed AND
  •  "post-petition" involving claims arising and events occurring AFTER the bankruptcy petiton was filed

Prepetition claims cannot be paid  - and collection cannot be pursued against the DIP company - absent specific authorization by the Bankruptcy Court.  Post petition claims can be paid in many instances if they arise in the ordinary course of the company's business and even if further authorization by the Bankruptcy Court is required,  generally go to the head of the line of unsecured creditors as administrative claims.

OVERVIEW OF TYPICAL CHAPTER 11 TIMELINE

The U.S. Courts' website provides a great summary of the typical Chapter 11 process, as well as the Offical Forms to be used by the company filing bankruptcy.  While there is no set timeline in a Chapter 11 (for an excellent visual representation of precisly how complicated things can get, look at the well known LoPucki's Bankruptcy Procedure Charts designed by UCLA law professior Lynn M. LoPucki) , some of the usual benchmarks might include the following:

ONE YEAR BEFORE PETITION IS FILED  - "Preference" period for "insiders" begins

NINETY DAYS BEFORE PETITION IS FILED - "Preference" period for noninsiders begins

PETITION DATE ("P") -   Day that Chapter 11 VOLUNTARY Bankruptcy Petition is filed   (Assume this is January 1, 2009)

  • Bankruptcy Petition is only a few pages and easy to complete
  • Must also include Creditor Matrix - list of names and addresses of all creditors
  • List of Credtiors Holding 20 Largest Unsecured Claims must also be filed.
  • Numerous "first day" motions filed (different ones in different cases), including motions for
    • Appointment of Debtor's Counsel
    • Appointment of other professionals being retained by Debtor (CPA, etc.)
    • Payment of prepetiton employee wages and benefits
    • Interim financing
    • Interim use of "cash collateral", i,e. proceeds generated from collateral on which a creditor has a lien
    • Authorizing honoring of Prepetiton Obligations to Customers in the form of warranties or gift certificates
    • Ensuring uninterrupted use of utlities
    • Extension of time to file bnakruptcy schedules

>>>> Meet with U.S. Trustee, open DIP (debtor-in-possession) bank accounts  

>>>> Resolve use of cash collateral issues, if not (hopefully) already done 

 P+15 days: (January 16, 2009)  Statement of Financial Affairs  and Schedules of Assets and Liabilities  must be filed unless deadline extended by Bankruptcy Court,  (In large cases, deadline often extended several times.)   Schedules include  a Summary, as well as the following  (Schedule I-Current Income and Schedule J-Current Expenditures relate only to individuals).

  • Schedule A      Real Property
  • Schedule B      Personal Property
  • Schedule C      Property Claimed as Exempt (not relevant for non individual debtors)
  • Schedule D      Creditors Holding Secured Claims (includes both fully secured and only partially secured creditors)
  • Schedule E      Creditors Holding Unsecured Priority Claims (continuation sheet)
  • Schedule F      Creditors Holding Unsecured Nonpriority Claims
  • Schedule G      Executory Contracts and Unexpired Leases
  • Schedule H      Codebtors

Completing the Statement of Financial Affairs which relates to debtor's prepetition behavior with respect to its assets, liabilities, and revenues, and especially all of the above bankruptcy Schedules relating to the debtor's assets and liabilities, is extremely time consuming.  The larger the business, the more complicated the process becomes.  in addition, companies needing to file bankruptcy often may not have had the best recordkeeping to begin with.  

>>>> UNSECURED CREDITORS' COMMITTEE FORMED (usually within the first couple of weeks following the Petition Date) based on the identity of the Twenty Largest Creditors as listed by the Debtor.  Generally selected by U.S. Trustee.  Motion for Appointment of Counsel for Creditors' Committee filed.  In smaller Chapter 11 cases, often no Unsecured Credtiors Committee is ever formed.  Purpose of Creditors' Committee is to represent the interest of creditors with smaller unsecured claims .

P+30 Days (February 1, 2009) - first Monthly Operating Report due showing results of postpetition activities.

>>>>>FIRST MEETING OF CREDITORS (aka 341 Meeting because it is mandated by 11 U.S.C. 341) conducted by U.S. Trustee at which debtor's representative answers questions under oath from creditors about the factors triggering the filing, status of assets (including those pledged as collateral), and plans for restructuring.

>>> continued filing of Monthly Operating Reports

>>>>Miscellaneous stay relief, adequate protection, lease and executory contract assumption/rejection issues arise; adversary proceedings filed

>>>>Revisit or further establish cash collateral arrangements and post-petition financing arrangements

>>>Establishment of a BAR DATE for when proof of claims must be filed by creditors

>>>>Begin formulation and negotiation with pertinent creditors regarding terms of Plan of Reorganzation, including proposed classification and treatment of claims

>>>Begin analysis of potential preference recoveries.

P+120 DAYS (May 2009) - Expiration of "exclusive period" during which only DIP is permitted to file plan of reorganization.  Exclusive period often extended at request of DIP by Bankruptcy Court. 

>>>> PROOF OF CLAIM BAR DATE - all creditors not agreeing to amount of claim shown in bankruptcy schedules must have filed proof of claim form to participate in any distributions

>>>>> Continued formulation and negotiation of Plan of Reorganization.  Proposed PLAN OF REORGANIZATION and proposed DISCLOSURE STATEMENT filed.  Disclosure Statement must summarize contents of proposed Plan and provide "adequate information" concerning the Plan and its implementation.

  • At least a 25 day notice period is required for hearing on Disclosure Statement
  • Once Disclosure Statement approved,  proposed Plan of Reorganization, approved Disclosure Statement, and Ballot for voting on Plan must be distributed to all creditors and parties in interest.
  • Revision and extensive negotiation of Plan often required

>>>>> CONFIRMATION HEARING on proposed Plan of Reorganization

  • At least a 25 day notice period is required for confirmation hearing  
  • Ballots must be tabulated - at least a majority in number and two-thirds in amount of claims voted in at least one class of impaired claims required for confirmation
  • Other confirmation requirements (including provisions governing contents of plan) set forth in sections 1126 and 1129  of the Bankruptcy Code such as feasibility must be satisfied

 >>>>PREFERENCE ACTIONS and other adversary proceedings intiiated.

>>>> Claims determination and allowance proceedings

That, somewhat oversimplified, is the timeline of a typical Chapter 11 case.  Because there is often no way to know how long it may take to reach agreement or determination of such crucial issues as the valuation of particular property securing creditor claims, it is rarely easy to predict how long any particular case may take to resolve sufficient issues for the company to emerge from bankruptcy.  Along the way, questions as to whether the company has the ability to service even a debt burden as permitted to be modified under the Bankruptcy Code may arise.  

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Posted on December 1, 2008 by Teri Rasmussen

How Prepackaged Bankruptcy REALLY Works

If you've been paying any attention at all to the national news of late, you know that Detroit's Big Three automakers are in deep trouble and that a substantial number of folks seem to think that forcing them into a "prepackaged " bankruptcy is the ANSWER.  When I first heard this, I thought this seemed like a pretty good idea ....  until I started really thinking about both what can and can't be accomplished  with this sort of Chapter 11 bankruptcy proceeding. 

So in a two-part post, I want to first explore the nature of the beast  those of us in the "biz" call a "prepack" and then focus more specifically on how it might actually operate in the context of the problems being faced by America's automakers.  While superfically appealing, a prepack is far from the panacea some seem to think it could be.  To understand why, you first have to understand how prepacks work in general.

Prepack Coming of Age.  Chapter 11 (and they always are Chapter 11 reorganizations) prepackaged bankruptcies came to the fore about twenty years ago.  Many say that  Dallas based hospital owner Republic Health Corp. was the first successful prepack with a plan confirmed less than five months later.  Prepacks became somewhat more popular during the 1990's in the context of failed LBO's, to implement mass-tort settlements, or as a vehicle to consummate sales or mergers of companies.   In the August issue of the Turnaround Management Association's Journal of Corporate Renewal, an article by Douglas Foley and James Van Horn entitled "Prepacks on the Rise in Chapter 11 Bankruptcies Prenegotiated Plans Can Accelerate Reorganization", asserts that there has recently been renewed interest in this variation of Chapter 11 with four filed in 2007 and more than a dozen filed in the first half of 2008. 

Companies utilizing the prepackaged option have included Donald Trump's Taj Mahal Casino in Atlantic City, Zenith Electronics, Aurora Foods-Pinnacle Foods merger, and TWA.  More recent participants have included Davis Petroleum (Case No. 06-20152, Bankr. S.D. Tex.) (whose plan was confirmed less than a week after filing), Blue Bird Body Co. (Case No. 06-50026, Bankr. D. Nev.), Bally Total Fitness (Case No.07-12395, Bankr. S.D.N. Y.), and Mrs. Fields' Original Cookies (Case No. 08 - 11953 , Bankr. D. Del.) (plan confirmed in less than sixty days after bankruptcy filed).

To promote organization and judicial economy, some jurisdictions such as the Northern District of California Bankruptcy Court and the Southern District of New York Bankrptcy Court have even adopted local rules governing prepackaged bankruptcies.   

Prepack Advantages.  The hallmark and principal advantage of a successful prepack is a substantial savings in time and disruption as compared with the ordinary Chapter 11 bankruptcy case.  The average Chapter 11 case, even a relatively small one, is rarely likely to be completed in less than a year and it can often take two or three years, or even longer, for a company to emerge from Chapter 11.  By contrast, prepackaged cases typically take less than six months, thus saving both time and money typically spent on case administration.  Conventional wisdom also holds that deterioration of the intrinsic value of a business which is often a consequence of a Chapter 11 filing and the attendant uncertainty is lessened through use of the prepackaged option.  (For a general discussion of the general effect of a Chapter 11 bankruptcy on a public company's shareholders, visit the discusssion of "What Every investor Should Know ... Corporate Bankruptcy" on the SEC's website.)

Technically, a prepackaged bankruptcy differs from a prenegotiated bankruptcy in that votes for a plan of reorganization have already been solicited and agreed upon prior to the filing, thereby leaving nothing to chance when it comes to achieving a successful confirmation of the Plan of Reorganization.  In a prenegotiated bankruptcy, actual votes or agreements to vote have not yet been reached with the critical mass of creditors, although resolution has typically been reached with those creditors deemed most crucial to success. 

The most important characteristic of a prepack  (or a prenegotiated bankruptcy) is that the major players in the bankruptcy have come to an agreement among themselves about the most important issues of subsequent financing, lien priority, and the extent to which the debt owing will be discounted or terms of repayment extended.  This reduces the potential for the debtor to lose control of the proceeding and allows it to proceed directly to its contemplted reorganized operations.  By minimizing the time spent subject to the restrictions and various oversight provisions embodied in the Bankruptcy Code and reaching important agreement before  even filing, the liklihood of full blown creditor second-guessing and need to balance the influence of various interests is thought to be significantly and productively decreased. 

Nuts and Bolts.  Section 1126(b) of the Bankruptcy Code and Bankruptcy Rule 3018(b) explicitly allow prepetiton solicitation of votes for approval of a Plan of Reorganization as long as certain procedures are observed.  The key elements to a successful prepetiton solicitation crtical to making a prepack a "go" are:

  • The proposed plan must have been transmitted to substantially all creditors or equity security holders entitled  to vote in a class;
  • Sufficient time  must have been allowed for voting (or in the words of the statute, the time allowed must not be "unreasonably short" which is of courae a case by case judgment call)
  • Those solicited must have been provided with "adequate information" in connection with the solicitation of their vote.
  • The provisions of any applicable nonbankruptcy law  such as federal securities law governing communication with shareholders of public companies must be complied with.

In essence, a prepack allows the debtor to bypass the lengthy time (starting with a 25 day notice period  for a hearing on the Disclosure Statement) involved in getting a disclosure statement approved by the Bankruptcy Court, distributed to creditors, and gathering/tabulating ballots approving or rejecting the proposed Plan of Reorganization.  There is of course the risk that the Court will determine after the fact that the prepetition solicitation process did not meet the requirements set forth above; this can happen either as a result of a motion by a party in interest on the Court can make such a finding on its own initiative.

What a prepack does not do, however, is change the requirements concerning creditor approval of a Plan of Reorganization.  Pursuant to section 1126(c), a class of "impaired" creditors (i.e. those not being paid in full) will be deemed to have accepted the plan if and only if the creditors in that class voting hold two-thirds in amount and at least a majority in number of claims voted do in fact vote to accept the plan.  In addition, pursuant to section 1129(a)(10), the plan cannot be confirmed unless at least one class of impaired creditors vote to accept the plan.  there are also the other usual requirements of feasibility and the like. 

Prepack Risks and Obstacles.  Prepackaged bankruptcies tend to work best where there are a limited number of sophisticated secured creditors involved with whom productive negotiations can actually be had.  They tend to work less well when a debtor has a large number of creditors, especially if unsecured, with a variety of different claims ( e.g. trade creditors, employees, landlords, equipment lessors,etc.) entitled to varying treatment under the Bankruptcy Code and which may fluctuate considerably during the period immediately preceding a filing.  Large numbers of contingent claims can also be an obstacle for the obvious reason that time must be spent determining how to estimate the amount of such claims.

In addition, by immediately proceeding to the plan confirmation phase, a debtor does lose the benefit of the "breathing spell" provided by the automatic stay which arises immediately upon the filing of the petition.  And, of course, it does tip the debtor's hand as to its financial distress (which may often be obvious anyway).

Drawing Conclusions.  While there are certainly some useful rights and remedies available to Detroit's Big Three should they decide to file Chapter 11 - being able to shed burdensome labor and/or dealer contracts springs to mind - there are also substantial risks - will consumers continue to spend thousands of dollars to buy vehicles from a car company in bankruptcy.   Prepackaged bankruptcy seems to be advanced by many of its advocates as a way to maximize the advantages of being a Chapter 11 debtor while eliiminating the "down side" of a bankruptcy filing.  I just don't think it's that simple.

So next time I will focus more specifically on how well suited the prepack option really is for Detroit's Big Three and what it might and might not be able to do for them.,

UPDATE:  In the first quarter of 2009, prepackaged bankruptcies hit an 8 year high with more than in all of 2008.

Also thanks to Scott Jagow of American Public Media's Scratch Pad for putting a practical spin on how this would apply in a Chrysler bankruptcy.

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