Related Practices

• Bankruptcy and Creditors' Rights

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”).  After eight years of intense lobbying by credit card companies and other financial institutions, the new law represents the most significant changes to the Bankruptcy Code in a quarter century.  To date, most media attention has focused on the consumer impact of the new law; however, the law includes a number of significant changes that will directly affect businesses and commercial transactions.  In fact, a new chapter of the Bankruptcy Code has been added, which has sections entitled “General Business Bankruptcy Provisions” and “Small Business Bankruptcy Provisions.”  Notwithstanding the section headings, some of the “small business bankruptcy provisions” are applicable to small and large businesses alike.  

A few highlights of the new business provisions include:

• Preference Actions:  In recent years, there has been a proliferation of preference actions.  The Act includes three significant changes that could reduce both the number of preference claims and any ultimate exposure.  First, in business bankruptcies, the new law indicates the payments to a creditor within the preference period (90 days prior to the bankruptcy filing for non-insiders) must total at least $5,000 before any preference could be recovered.  Second, certain preference actions, those where the plaintiff seeks to recover less than $10,000, must now be brought in the jurisdiction where the defendant resides.  These two changes should reduce the number of small preference actions.  In the past, a Pennsylvania company could be sued in a California Bankruptcy Court.  Under the Act, a California debtor or trustee would have to commence the preference action in Pennsylvania if the claim is under $10,000 and could not bring the action at all if the alleged preferences were under $5,000.  Third, the ordinary course of business defense has been modified so that defendants need only show that payments were made in a manner consistent with the parties’ normal business practices; evidence that the parties’ normal practice also conformed to industry norms is no longer required.  This latter change should make the ordinary course defense more readily available.  It also will make it more important to properly manage your dealings with a troubled customer in the period preceding that customer’s bankruptcy filing.  Finally, the expanded reclamation rights (discussed below) may also provide some defenses to preference claims, if the creditor takes advantage of the expanded rights.

• Reclamation Matters:  Under current law, creditors who shipped goods to the debtor in the ten days prior to a bankruptcy filing could try to recover those goods or obtain a priority administrative expense claim by sending the debtor a Notice of Reclamation (“Notice”).  While we continue to advise clients to send such Notices, complete reclamation often was difficult to obtain.  If the debtor had already sold the goods, or if the debtor had a secured creditor, like a bank, with a security interest in inventory, the reclamation could be opposed.  The Act makes two significant changes to the reclamation process.  First, creditors may now reclaim goods sent to an insolvent debtor for the 45 days prior to a bankruptcy filing.  Notice must be given within that 45 day period or during the first 20 days of the bankruptcy if the 45 day period expires after the commencement of the case.  This should make it easier for suppliers to comply with the Notice requirements and to reclaim more goods.  Second, regardless of any reclamation rights, creditors are now given a priority administrative expense claim for goods shipped in the ordinary course of business to a debtor in the 20 days prior to the bankruptcy filing, although it may be necessary to file a motion to obtain such administrative expense status, or payment.

• Real Estate Matters:  The Act includes a number of provisions regarding leases of non-residential real property which will have a significant impact on lessees and lessors alike.  These provisions include a strict time limit on the time a debtor has to assume or reject a lease and a cap on certain post-petition rejection damages.

• Chapter 11 Plan Exclusivity:  Currently, Section 1121 of the Bankruptcy Code contains a 120-day exclusivity period during which a debtor has the exclusive right to file a Chapter 11 plan.  This period could be extended for “cause” which courts routinely allowed, even if such extensions of the period continued for years.  The Act strictly limits the exclusivity period to 18 months, which will likely lessen the overall time it takes to get a plan of reorganization confirmed.  For creditors who often do not receive disbursements until after plan confirmation, this provision may expedite the receipt of such payments.  It also should generally shorten the life of many Chapter 11 cases, which, in turn, should reduce the associated cost.

• Small Business Bankruptcy Cases:  The Act places limits on the availability of the automatic stay if a small business debtor has filed a previous bankruptcy case.  A small business debtor is defined as a person engaged in commercial or business activities, other than owning or operating real estate, with no more than $2 million in debt.  Interestingly, the same limits also apply to a business debtor which has acquired substantially all of the assets of such a small business debtor.  This should reduce the number of serial filings by small businesses or sole proprietorships and give creditors more options if a serial filing does occur.

• Consumer Insolvency:  In addition to the provisions relating to businesses, the Act aims to limit abuses of the bankruptcy process at the consumer level by requiring individual debtors to take a course in personal financial management, limiting individual debtors’ access to Chapter 7 of the Bankruptcy Code, limiting serial filings, and in some cases, dispensing with the automatic stay.  These provisions may be particularly useful to lenders or other creditors with a significant number of individual customers.  Moreover, the provisions apply not just to consumer debtors, but also to individual debtors with business debts, such as sole proprietors or guarantors.

For the most part, the Act goes into effect on October 17, 2005.  However, there are numerous exceptions that may make certain provisions effective earlier.

For more information, please contact your Cohen & Grigsby attorney or Cohen & Grigsby’s Bankruptcy and Creditors' Rights Group at 412.297.4900.