There are several key factors for the rise and continued use of the “Fast-Track Business Bankruptcy Cases.” Since the tightening of liquidity in the credit markets, starting in the later part of 2007 and the complete shutdown after the Lehman Brothers bankruptcy in September 2008, debtor-in-possession (DIP) financing from new sources other than the current lenders has been virtually impossible to obtain. Many distressed entities are the by-product of highly leveraged transactions that closed in the 2004-2007 timeframe and now as asset and enterprise valuations are extremely depressed there is no collateral cushion or free assets that can be used to fund a traditional restructuring in bankruptcy.
One of the biggest reasons for the fast-track process can be attributed to the changes in the Bankruptcy Code in 2005. The impact of these changes were not felt until the economy had a downturn and filing bankruptcy was an important business alternative. The bulk of this article deals with these changes and how they have given rise to the fast-track bankruptcy process.
A major thrust of the drafters of Chapter 11 of the Bankruptcy Reform Act of 1978 was to develop a flexible, adaptive and transparent system that was business plan agnostic. Our original Chapter 11 design permitted a debtor a broad range of discretion, consistent with the exercise of sound business judgment and the best interests of the estate, to develop a business plan with the greatest chance of success. This system rested on a number of provisions in the Bankruptcy Code, including the stay of any creditor action against the debtor or property of the estate, relief from the payment of prepetition claims, a high priority in payment for those entities that deal with the debtor post-petition, the ability of the debtor to remain in possession of property of the estate, the ability of the debtor to continue to operate the business in the ordinary course without court approval, the ability of the debtor to incur debt post-petition, the exclusive right of the debtor to propose and confirm a plan of reorganization, and the discretion to either reject or assume (and assign) unexpired leases and executory contracts.
The drafters infused discretion throughout the process with both the debtor, in the first instance, and the bankruptcy court. They recognized that famously, bankruptcy is a flexible process. Thus, the actual structure of the business plan was driven by the financial facts and circumstances on the ground and the sensibilities of the stakeholders, rather than any particular provision or combination of provisions found in the Bankruptcy Code. This is no longer the case.
On April 20, 2005, former President George W. Bush signed into law Senate bill number 256, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). BAPCPA is the most substantial revision of bankruptcy law since enactment of the Bankruptcy Reform Act of 1978. More specifically, BAPCPA dramatically changed several aspects of business bankruptcy law relevant to retail debtors. BAPCPA generally became effective as to cases filed on or after October 17, 2005.
Although BAPCPA garnered considerable media and commentator attention, most of that focus centered on controversial consumer amendments. Passing largely unnoticed to many were a small but significant number of business bankruptcy provisions that would rattle the manner by which business bankruptcy cases would be handled by the major constituencies in the bankruptcy process. Three changes to the Bankruptcy Code amplify the significance of the effect BAPCPA has had on the business bankruptcy process. These changes are:
- BAPCPA imposed a hard deadline by which commercial real property leases must be either assumed or rejected, placing a cap of 210 days. By that time, a lease is deemed rejected if not assumed. This has had a substantial affect on the profile of retail and food establishment bankruptcy cases, where large numbers of leases are in play.
- BAPCPA imposed a hard deadline for the period of exclusivity by which only the debtor may file and have confirmed a plan of reorganization. Now the law sets a cap of 18 months at the outside, with no judicial discretion or power to extend the period of exclusivity further. The period of exclusivity is the period by which only a debtor may propose and obtain confirmation of a plan of reorganization. During this period, no other party may file a competing plan until that time period lapses.
- BAPCPA created a new administrative priority for goods sold to the debtor within 20 days of the bankruptcy filing. This priority generally has posed a serious drag on cash flow. An administrative priority claim generally must be paid in full and in cash as of the effective date on a confirmed plan. This provision, Bankruptcy Code §503(b)(9), has spawned considerable litigation over timing and amount of payment.
These changes sought to recalibrate the relative balance of power between business debtors and their creditors, largely by removing the discretion of bankruptcy judges. The intended changes were designed to speed up the bankruptcy process and, thus, minimize the perceived abuse of bankruptcy through delays of the inevitable. The unintended consequences include a change in the profile of the typical business bankruptcy case. Today’s business bankruptcy case is fast-tracked and designed to preserve intrinsic value. These modern cases, unlike their more traditional rehabilitative ancestors, are all about asset sales, often in the form of management buyouts, where bankruptcy is used to cleanse assets from competing claims and interests, provide a short-term capital structure fix, and/or allow a federally subsidized asset foreclosure process to go forward often for the benefit of secured creditors only.
Four examples help provide context to the issues raised. SIRVA, Inc., a privately owned moving company, filed for Chapter 11 bankruptcy relief in early 2008 in the Southern District of New York. Judge Peck ultimately confirmed a plan of reorganization that had been pre-approved by 96% of SIRVA’s creditors prior to filing. The case itself is an excellent example of the pre-negotiated post-BAPCPA Chapter 11 plan. A pre-negotiated plan is not the same thing as a pre-packaged bankruptcy case. In the “pre-pack” scenario, the debtor prepares a plan and solicits class acceptances before the bankruptcy case is filed. A pre-negotiated plan lacks the necessary acceptances to support unanimous class acceptances and proceeds under the Chapter 11 plan cram-down process.
Freedom Communications Holdings, Inc., a privately owned newspaper company, filed a Chapter 11 bankruptcy case in the District of Delaware. There, Bankruptcy Judge Brendan L. Shannon approved a plan of reorganization whereby the prepetition secured debt holders, comprised mainly of non-banks, distressed debt buyers and private equity groups would purchase Freedom. In this case, bankruptcy was used as a part of the acquisition process. There, the debtor’s balance sheet would be scrubbed of the majority of its debt. This is another of the types of fast-track cases.
CIT Group, Inc., a commercial lender specializing in accounts receivable factoring, among other financial products and services, filed for a pre-packaged bankruptcy in the Southern District of New York during the throws of the credit crisis. The pre-packaged plan of reorganization was approved by Judge Allan L. Gropper, where ownership was essentially transferred to the company’s secured creditors.
Finally, Lyondell Chemical Company, the world’s third-largest chemical manufacturer, filed petitions for relief under Chapter 11 of the Bankruptcy Code in the Southern District of New York. Judge Robert E. Gerber ultimately approved the plan of reorganization whereby Lyondell’s secured creditors ultimately wound up owning the newly reorganized company. Although the case took about a year, given the complexity and magnitude of the debtor and its operations, this case can be easily characterized as “fast-tracked.”
These are four examples of fast-track bankruptcy cases. Although these cases involve very different industry sectors and their distress often caused by different things, their bankruptcy processes had much in common. These commonalities highlight the effective use of the expedited procedures and policies in place in bankruptcy post-BAPCPA and are generally consistent with many of the policies that have driven bankruptcy reorganization over the past 70 years.
These bankruptcy cases are primarily about preserving intrinsic value. The stakeholders, or at least many of them, recognize that time in bankruptcy erodes value. They also recognize that administrative costs may be reduced by shorter time in bankruptcy court. Moreover, stakeholders recognize that bankruptcy as a process is at its best when it is used to preserve value through the deleveraging of the balance sheet, often swapping secured and critical debt for new equity in the reorganized debtor, or by an expedited sale that often accomplishes the same goals.
These fast-track cases are not without institutional and individualized costs. Because these assets sales or pre-negotiated plans are not consensual, there is usually a particular class or classes of holders of claims that have been left out of any meaningful distribution. Often, it appears as though the sale or plan proponents are “steam-rolling” these classes (usually non-critical trade creditors and bondholders; occasionally tort claimants as well). However, a robust creditors committee, represented by capable legal counsel and financial advisors, is usually able to modify the process to ensure the protection of the creditors. Furthermore, bankruptcy judges are well aware of the dynamics of these processes and, in most instances, will slow down the process to ensure a meaningful opportunity for the committee to vet the process.
Most, if not all, of these fast-track cases are done to deleverage the balance sheet and little is typically done to correct operational issues. The lack of funding and time to restructure the way the debtor does business, reduce costs, eliminate non-core businesses and truly turn around the business is lost in the fast-track process. It is not known if these entities will be viable and survive post bankruptcy without making the needed improvements to their operations.
Another developing issue that may mature into a negative, at least in some instances, is the scenario where certain critical insiders of the debtor use the fast-track process to gain more leverage in their purchase of the assets or equity in the reorganized debtor. In these situations, old equity holders may use bankruptcy as a bootstrap to acquire the assets free of debt in a manner that may not be possible under applicable non-bankruptcy law. Although bankruptcy law and policy contemplates such a result, insiders must square their corners when proposing such a result.
The post-BAPCPA bankruptcy world places a premium on speed. That should not surprise us. Time is money, as we are often reminded. Speed is a good thing in the bankruptcy process, and brings many tangible benefits. But like most good things, one has to ask at what cost? The answer to that question is still in the making.
William K. Lenhart, CPA, CIRA, CTP, CFE, is the national director of the Business Restructuring Group at BDO USA. He is based in New York. Lenhart can be reached via e-mail at email@example.com.
Professor Jack F. Williams, JD, CIRA, CDBV, is an AIRA Scholar in Residence at Georgia State University in Atlanta. Williams can be reached via e-mail at firstname.lastname@example.org.