Intended to curb abuses by debtors, changes in the new bankruptcy law (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)), which took effect in October 2005, have made it more costly for businesses to reorganize and more difficult for existing management to control the troubled company's destiny. As a result, business reorganizations are down (more than 50 percent in 2006) and restructuring outside of bankruptcy has increased.

Where bankruptcy is filed, "prepackaged" Chapter 11 plans, in which consent of major creditors for a planned restructuring is obtained before filing bankruptcy, are increasing. Such plans reflect the reality that in order to avoid the increased expense and potential loss of control over the process under the new law, debtors must strike deals with secured lenders and other major creditors before filing to try to ensure confirmation.

This article will discuss some of the key BAPCPA changes that have made it more costly and difficult for businesses to reorganize and some of the recent decisions interpreting those changes.

Shorter Exclusivity
A key change reducing the debtors' control of the bankruptcy process is the shorter exclusivity period. Before BAPCPA, the debtor had the exclusive right to file a plan during the first 120 days following the filing of a bankruptcy petition and 180 days to have that plan accepted under section 1121 of the bankruptcy code. But courts had wide latitude in giving extensions and typically granted extensions long beyond this period. In large corporate bankruptcies, several extensions of the period were often necessary for the debtor to complete the groundwork required to present a confirmable plan, and confirmation could take several years. United Airlines took three years to confirm its plan in 2005; Adelphia took more than four years.

Under new section 1121(d)(2), the debtor's 120-day exclusive period to file a plan may not be extended beyond 18 months and acceptance of the plan is capped at 20 months. Many companies rushed to file before the new law took effect in October 2005, no doubt in part to avoid the shorter exclusivity period and the pressure this puts on debtors, especially larger debtors, who have to negotiate with various creditor constituencies, vendors, labor unions, nonunion employees, and other groups in trying to reorganize. All of the recent large airline bankruptcies (Delta, Northwest, and Mesaba) were filed shortly before the new law took effect.

For small business cases (involving total debts of less than $2 million), the exclusivity period is even shorter under revised section 1121(e): 180 days unless extended by the court for cause, with a drop-dead deadline of 300 days. One Florida bankruptcy court has held that the 300-day exclusivity limit for the debtor does not apply to interested parties other than the debtors and that such parties may file competing plans immediately after the period expires. Florida Coastal Airlines, Inc.,361 B.R. 286 (Bankr. S.D. Fla. 2007).

Florida Coastal also illustrates how a shorter exclusivity period contributes to the debtor's loss of control of the process when a party files a competing plan, as can now be done in small business cases after 300 days, with the intent to take over a company. While the court held that an amended plan filed by the debtor after the 300-day period "related back" to the date it filed its original plan before expiration of the 300 days (and was therefore timely), it denied the debtor's motion to invoke exclusivity, ruling that a company that had unsuccessfully tried to acquire the debtor prefiling and purchased a bankruptcy claim in order to become a creditor and party in interest could file a competing plan only 317 days after the filing.

The shortened exclusivity period and stricter rules for small business debtors make it especially difficult for them to reorganize, incentivizing them to try to reach agreements with secured lenders prior to filing.

Key Employee Retention
Another change imposing a new restriction on debtors deals with key employment retention policies (KERPs). New section 503(c)(1) was intended to rein in the practice of paying generous incentive bonuses to keep key executives on the job after bankruptcy, while rank-and-file employees suffered, by restricting "retention" and severance payments to insiders.

New section 503(c)(1) prohibits administrative claims for payments to "insiders" for the purpose of inducing them to remain with the business

absent a finding by the court based on evidence in the record that . . . [the payment] is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; [and] the services provided by the person are essential to the survival of the business.

In addition, the amount of the payment must not be more than 10 times the amount of payments of a similar kind given to nonmanagement employees during the same calendar year, or, if no similar payments were made to nonmanagement employees, more than 25 percent of the amount of any similar payments made to the insider during the prior year.

New section 503(c)(2) prohibits severance payments to insiders of the debtor, unless made as part of a program that generally applies to all full-time employees and is not more than 10 times the amount of the mean severance pay given to nonmanagement employees during the same year.

In response to this change, debtors are filing detailed motions for court approval to enter employment agreements with their key executives and having to show that the compensation packages do not include "retention" payments in order to avoid the limitation in the amount of the payments. For example, in In re Dana Corp., 358 B.R. 567 (Bankr. S.D.N.Y. 2006), the debtors moved for an order authorizing them to enter into employment agreements with their CEO and five key executives, including pension benefits. The bankruptcy court initially denied the motion, but the debtors then revamped their compensation proposals with input from creditors, eliminating guaranteed payments other than base salary, but including incentive payments based on achievement benchmarks and moved for reconsideration.

The court approved the revised compensation package, finding it properly incentivized the key executives to produce and increase the value of the bankruptcy estate, and also that section 503(c)(1) did not apply because the payments were not in the nature of "retention payments," but rather were payments in the ordinary course, despite their "incidental retentive impact."

Relying in part on the Dana decision, a similar result was reached in In re Global Home Products, LLC, 2007 WL 689747 (Bankr. D. Del. 2007). In Global,the court approved executive compensation plans over the objections of the union, also finding that the plans were incentive rather than retention plans designed to achieve performance for the debtor's benefit, consistent with industry standards and virtually identical with plans used by the debtors before bankruptcy, and that their costs were reasonable and were included in the budget approved by the debtor's post-petition lenders.

The new law thus puts executive employment plans under greater scrutiny and severely limits the rights of bankrupt companies to make retention payments to executives. Debtors should plan on incurring the expense of demonstrating to the court that payments to key employees after bankruptcy are in the nature of incentives, as opposed to retention payments; are reasonable; and do not harm the company.

Creditors' Committees
Another expense-adding change stems from the new duties of creditors and other committees under new section 1102(b)(3), which now requires creditors' committees to provide access to information to creditors represented by the committee who are not on the committee, solicit their comments, and subject them to court orders that may compel additional reporting or disclosure to those creditors. The new section does not define "information."

In In re Refco Inc., 336 B.R. 187 (Bankr. S.D.N.Y. 2006), fearing that this section might be interpreted to impose an obligation contrary to other applicable laws and the committee's fiduciary duties and to hamper the committee's performance of its other powers and duties, the committee of unsecured creditors moved for an order regarding its obligations to provide information to nonmember unsecured creditors under the new section.

Interpreting section 1102(b)(3) for the first time, the court analogized the committee's duties to provide information to that of a Chapter 11 trustee and held that the duty to provide information is not unlimited and that the committee would not be required to disclose information that could reasonably be determined to be confidential and nonpublic or proprietary, or disclosure of which could reasonably be determined to result in general waiver of the attorney-client or other applicable privilege, or whose disclosure could reasonably be determined to violate an agreement, order, or law.

The Refco court also held that the committee could satisfy its disclosure obligations by proactively providing specified types of information on a Web site, including general information regarding the case, monthly committee reports, and calendar of upcoming significant events, and, in addition, distributing case updates via electronic mail to creditors that had registered for this service and establishing a telephone number and e-mail address for creditors to submit questions and comments.

Attorney fees incurred by the creditors' committee are entitled to administrative expense status under section 503(b)(2). The added expense for legal fees incurred by committees in complying with the new statute or seeking the court's guidance as occurred in Refco will further diminish estate funds for other creditors and equity.

New Claims for Suppliers
A new administrative expense was created by BAPCPA for trade creditors who sold goods to the debtor within 20 days of filing. New section 503(b)(9) provides for the allowance of an administrative expense for the value of goods sold and received by the debtor in the ordinary course of its business within 20 days before the date of commencement of a case.

In re Bookbinder's Restaurant Inc.,slip copy, 2006 WL 3858020 (Bankr. E.D. Pa. Dec. 28, 2006), the first reported decision regarding this new section, the court considered the issue of whether a trade creditor holding an allowed administrative expense under this section was entitled to immediate payment of the expense. The court rejected the creditor's argument that it was entitled as a matter of law to immediate payment of a section 503(b)(9) claim because the debtor was paying other administrative expenses including postpetition trade debt in the ordinary course pursuant to 11 U.S.C. § 363(c)(1). Instead, the court found that the timing of the payment of an administrative expense allowed under section 503(b)(9) is within the discretion of the bankruptcy court and that the court could consider the potential prejudice to the debtor, hardship to the claimant, and detriment to other creditors before compelling payment.

BAPCPA also changed the reclamation rights of the seller under section 546(c), increasing the time in which a seller may make a written demand for reclamation from 10 to 45 days after receipt of the goods, or 20 days after the case was filed if the 45-day period expires after the filing. The new section also expressly states that even if the seller fails to give the required written reclamation demand, it may still assert rights to a claim under new section 503(b)(9).

Unlike section 503(b)(9) administrative claims, section 546 reclamation claims are subject to holders of prior security interests in the goods. Courts have therefore held that "if the value of a reclaiming supplier's goods does not exceed the amount of the debt secured by the prior lien, the reclamation claim is valueless." In In re Dana Corp., 2007 WL 1199221 (Bankr. S.D.N.Y. 2007).

In Dana and in In re Advanced Marketing, 360 B.R. 421 (Bankr. D. Del. 2007), reclamation claims by suppliers were denied where goods received prepetition were subject to the prior liens on inventory of senior lenders and post-bankruptcy financing agreements with those same lenders did not extinguish, but rather reaffirmed, the lenders' first liens on the debtors' inventory. In contrast, in Phar-mor, 301 B.R. 482 (Bankr. N.D. Ohio 2003), a pre-BAPCPA case, reclamation was permitted where prepetition lenders had released security interests in exchange for full payment through a DIP facility.

Analyzing the interplay between new section 503(b)(9) and revised section 546(c) in Dana, the court observed that with the introduction of new section 503(b)(9) priority, reclamation claims under amended section 546(c) have decreased importance because goods delivered to a debtor in the 20 days prior to bankruptcy will have automatic priority. As a result, reclamation rights are now mainly beneficial for goods delivered in the 21 to 45 days prior to the bankruptcy filing under amended section 546(c). The court also noted that expansion of the reclamation period will increase the likelihood of early administrative insolvency so that debtor companies will need greater financial resources to reorganize.

The changes discussed above reduce the bankrupt debtor's control, add priority claims, and increase the costs to restructure. In the bankruptcy of Ohio auto parts maker Dana Corporation, one of the few large cases filed since BAPCPA took effect, $100 million in attorney and other professional fees were charged in the first year of the case alone.

Facing the possibility of such high expenses motivates debtors to work with lenders to put together a prepackaged plan. But what happens if agreement with lenders is reached on a prepackaged plan and equity holders object? In re Oneida Ltd., 351 B.R. 79 (Bankr. S.D.N.Y. 2006), involved a prepackaged plan filed by the debtors with the consent of their secured lenders post-BAPCPA. The Oneida equity holders' committee (institutional stockholders) objected to confirmation of the plan claiming that it was not proposed in good faith and that the lenders had used their control over debtors to induce the debtors to propose a plan under which debt would be converted into stock in order to seize value that should have gone to equity. The court overruled the objection and confirmed the plan, finding that it was proposed in "good faith" because the idea of converting debt into equity originated with the debtor's directors, not the lenders, and because the equity holders' committee was unable to produce "evidence that plan was proposed in bad faith or for ulterior purposes or constituted a scheme on the part of lenders to acquire an undervalued business, flip it, and make a substantial profit."

Practitioners representing debtors or lenders in negotiating prepackaged plans involving debt-to-equity conversion should analyze the value of equity to be received in relation to the amount of debt converted to avert such arguments, particularly where the debt has been sold by the original lender to entities with takeover aspirations.

Another emerging trend in the post-BAPCPA world may be an increase in Chapter 7 liquidation filings and liquidating Chapter 11 cases. Subprime mortgage companies Mortgage Lenders Network and ResMAE Mortgage Corporation filed for Chapter 7 relief earlier this year and quickly moved for approval to sell off their loan portfolios. Another subprime lender, New Century Mortgage, filed Chapter 11, but only so as to continue operations while selling off its assets, moving for court approval to sell pools of mortgage loans shortly after filing.

The extent to which BAPCPA changes are forcing debtors to be more realistic about the likelihood of successful restructuring in bankruptcy, thereby reducing the number of reorganizations that ultimately sink into long, slow deaths or, alternatively, are preventing companies that could otherwise reorganize from doing so, is difficult to assess. Perhaps it is a little of both. It is clear that the time pressures and expenses BAPCPA imposes on debtors give secured lenders more power than ever to negotiate favorable workout terms and, to a large extent, control the debtor's destiny.