Email Page Print Friendly Page Contact
learning center: publication detail
Issue 2: The Bankruptcy Code Amendments: Ramifications for Lenders
Lending & Restructuring Alert
June 2005
Authors: Paul A. Rubin

The amendments to the Bankruptcy Code contained in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 will affect not only consumer bankruptcies, but also business bankruptcy cases.  Most of the amendments apply to cases filed on or after October 17, 2005.  This is the second issue in a series of alerts explaining the Act's implications for commercial bankruptcies. It is critical for lenders to focus on the cumulative impact these changes are likely to have on commercial bankruptcy cases.  What can lenders expect?

Increased Risk of Administrative Insolvency, DIP Financings Are Likely to Become Larger, and the Trend Toward "Chapter 3 Cases" Should Continue

Under the new law, trade vendors will be entitled to assert administrative expense claims for goods received by debtors within 20 days of their bankruptcy filing that were purchased in the ordinary course of business.  A seller holding such an administrative claim will have the right to seek its immediate payment.  While debtors may attempt to delay such payment trade vendors will be entitled to adequate assurance that their administrative claims will actually be paid.

In addition, the new law expands the rights of trade vendors so that they will be able to reclaim goods sold on credit that a debtor received within 45 days of its bankruptcy filing, as long as no creditor holds a security interest in the debtor's inventory.  This 45-day window vastly exceeds the 10-day period provided by the Uniform Commercial Code. Bankruptcy court will no longer be permitted to deny reclamation of goods by granting the seller an administrative or lien claim.

As a result of these changes, obligations that were formerly general unsecured claims will become entitled to cash payment equal in priority to professional fees.  Debtors' estates will be saddled with higher administrative expenses.  This will create increased risk of administrative insolvency.  Moreover, to satisfy the increased administrative claims of trade vendors, debtors will be looking for larger debtor-in-possession loans that they would have under the old law.  Since plan confirmation requires cash payment of administrative expenses, which may not be feasible in some cases, the changes may accelerate the recent trend toward expedited sale of substantially all of a debtor's assets outside of the plan confirmation context.

Increase Pressure to Move Chapter 11 Cases More Quickly

Take together, several changes in the law will have the practical impact of preventing business bankruptcy cases from languishing as long as some cases have in the past.  As we explained in a separate newsletter, landlords will be able to require debtors to assume or reject commercial leases within 210 days of the bankruptcy filing.  Also, the debtors' exclusive periods in which to file plans or reorganization will be limited to 18 months, ending the routine court practice of granting virtually unlimited extensions where the debtors show some "progress" toward a reorganization.  This will encourage debtors to file and confirm plans more quickly, lest creditors become eligible to file competing plans.

The new law requires courts to conduct status conferences in Chapter 11 cases to assure their expeditious and economic resolution.  It also sets forth additional grounds for dismissal or conversion of Chapter 11 cases; the Code now lists 16 bases for dismissal or conversion, such as the failure to file a plan within a deadline set by the court, failure to file post-petition tax returns or pay post-petition taxes, and failure to maintain appropriate insurance. But a word of caution: The amendments permit a court to appoint an examiner or a trustee rather than dismiss or convert a case if it would serve the best interest or creditors and the estate.

Prepackaged bankruptcies, in which cases move quickly, are also encouraged.   The amendments exempt "prepacks" from the requirement that the United States Trustee conduct what is known as a "341 meeting" of creditors, and prepack cases may be excused from the requirement that a creditors' committee be appointed.  The amendments permit post-petition continuation of solicitation of plan votes based on pre-petition disclosure, if the creditor was solicited before the case was filed in a manner that complied with applicable nonbankruptcy law.

The bottom line: Congress wants Chapter 11 cases to move more quickly.

Expanded Period to Perfect Security Interests to Avoid Preference Liability

Under the Bankruptcy Code, the perfection of a security interest constitutes a transfer subject to avoidance as a preference.  Under the current law, for preferences purposes, the "transfer" is deemed made when it takes effect between the transferor and transferee, if the transfer is perfected within 10 days after the transaction in which the security interest was created, the "transfer" is deemed to take place at the time of perfection.  Under the new law, the grace period in which to perfect a security interest is expanded to 30 days. Thus, it will be easier for lenders to perfect their security interests and avoid liability on preference claims.

Surcharge of Lender's Collateral to Pay Taxes

Some courts have held that a debtor may not surcharge a lender's collateral for the cost of ad valorem taxes.  The amendments clarify that a debtor may do so.  This could result in a reduced recovery for the secured creditor.

For more information please contact Paul Rubin at (212) 592-1448 or prubin@herrick.com.

Herrick's Bankrupty, Business Reorganization and Creditor's Rights Practice Group represents a broad range of clients having varied interests in the bankruptcy, workout and reorganization arenas.  From Fortune 500 corporations to small public and private companies, our clients include all of the major players in the bankruptcy process: debtors, creditors' committees, secured and unsecured creditors, trustees, financial institutions, investment banks, ass-based lenders, insurance companies, pension funds, purchasers of assets, landlords, claims traders, equipment lessors and licensors. For more information on our practice, please visit www.herrick.com.

Copyright @ 2005 Herrick, Feinstein LLP. The Lender's Alert is published by Herrick, Feinstein LLP for information purposes only.  Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.