by Lara E. Shipkovitz, Esq.

A trade-for-debt equity swap offered by a debtor to a large creditor can provide a viable alternative to liquidation while offering that creditor potential more value on its debt and a role in the company’s future growth.  Specifically, where a failing business is in need of capital, it can offer a trade creditor to convert its existing debt into equity in the company – i.e., the creditors will forgive the debt owed to them by the failing business in exchange for a share in the business.  This might pose the question – why would a creditor want a share in a failing business?  In fact, such a swap can work to the advantage of both the creditor and the business.  If the creditor does not make the trade, the Debtor may become insolvent and forced to liquidate and the creditor in turn may get pennies on the dollar for its debt.  If however the trade debt is reduced, the failing business can pull itself up and the value of its equity can grow.

A debt for equity swap may be appropriate where a company is having solvency issues but is still ultimately viable, is over geared and/or is unable to obtain finance.  One example of where this proved to be a success was in the furniture retailer, Jennifer Convertibles, Inc., bankruptcy cases.  Prior to filing for bankruptcy, the company owed almost half of its total unsecured debt to a foreign furniture supplier.  This foreign furniture supplier was the debtor’s sole supplier for many of its products.  The supplier entered into an agreement with the Debtor prior to the filing of the bankruptcy agreeing to convert the debt into a controlling stake (90%)in the reorganized debtor’s new common stock.  Significantly, the Supplier also recovered more than 87% of its claim. See, ABI Journal, July/August 2011, “Converting Trade Debt to a Controlling Stake: The Pragmatic Path to Jennifer Convertibles’ Unique Reorganization”, Neiger, Edward E.

Obviously, the debt for equity swap works best when dealing with parties who are otherwise indispensable to a debtor’s reorganization.  An equity interest may be used such as ordinary shares, fixed coupon ordinary shares, preference shares and equity warrants.  It is important to recognize this swap also helps the debtor by reducing corporate debt, which in turn strengthens the balance sheet improving their borrowing position and status with customers, suppliers and other investors.  The swap however also is based on an inherent risk- that the reorganized business will be successful.  In the event the business cannot become solvent or the reorganization is impractical (and results in a liquidation), the creditor would lose its investment.  If successful however, this allows the debtor to substantially de-lever its balance sheet and significantly reduce its debt.  In sum, the pre-arranged swap for debt to equity prior to a business filing for bankruptcy can provide a creditor with potential for great recovery and opportunity if they are willing to take that risk.

by Jodi L. Hause, Esq.

             Having practiced in bankruptcy court in both consumer and commercial cases for the last eight years, I have seen a variety of pleadings crafted with varying degrees of creativity and skill.    On one hand, there are those that are so short and cryptic that it’s difficult to ascertain how exactly the party’s argument gets them from point A to point B.   Others are so painstakingly technical that the argument itself is lost in the monotony of citations, references, and legalese.    In my opinion, neither of these extremes do much to further your client’s interests.    Simply stated, the best pleading is the one that tells the most convincing story and makes the most sense to the adjudicator.   Too much or too little factual detail will only confuse and frustrate the reader (i.e. the Judge).   A winning pleading clearly states what relief is being sought and explains how the law applies to the relevant facts of the case.

           The Federal Rules of Civil Procedure are based upon the concept of notice pleadings.  The general rules of pleadings under the FRCP require that the pleading must contain (1) a short and plain statement addressing the Court’s jurisdiction; (2) a short and plain statement of the claim asserted in the pleading; and (3) a demand for the relief sought.  

            The notice pleading requirement is intended to be less formal and intended to simply provide notice to parties of the general issues in a case without having to allege detailed facts in support of the claims.   It is a general notice of asserted claims, the details of which can be fleshed out as the case progresses.  

            The result of the notice pleading requirement is sometimes the filing of bare bones motions and responses.   In some cases the factual details may not be available to supplement the pleading or response, but more often than not a bare bones pleading in a contested matter is a poorly drafted pleading.   The issues in contested bankruptcy matters are often complex, particularly in complex commercial matters.   Even the relatively straightforward matters often contain potentially mitigating facts and circumstances.   Every opportunity should be taken within reason to make clarity out of chaos.  

            In my experience, Bankruptcy Judges tend to be learned and prepared individuals.  They will take the time in advance of the scheduled hearing to read and understand the pleadings filed in the matters before them.   Accordingly, your filed pleading is the very first opportunity for you to present your side of the story to the Judge.   If you have written it in a way that clearly and concisely explains your client’s position and how the law supports that position, then you are on the right path.   The benefits of a well-written pleading are far out-weighed by the additional time it takes to draft it.     A well-written pleading will lay the foundation for a solid argument and will make your job at the hearing that much easier.   It will enable you to more effectively and efficiently argue in support of your client’s position at the hearing and will enable you to be a better advocate overall.

by Robert S. Bernstein, Esq.

Since the late 1970s, the public really started to learn about Chapter 11 and how it works in “big companies.”  Through the 80s and 90s with the airlines and the steel companies, it became more “routine” for big companies to file Chapter 11 bankruptcy.  Today, of course, we are hearing about the Chrysler Chapter 11 and the likely GM Chapter 11.  Whether the cases are quick (as promised) or longer (as likely), it would be good to revisit the basics of Chapter 11 so we can all better understand what is happening.

In light of the newsworthy filing by Chrysler and the probable filing by GM, having a basic understanding of Chapter helps explain some of the maneuvering.

It is Bankruptcy.  The Bankruptcy Code is a federal statute (Title 11, United States Code – the “Code”).  Chapter 11 is the business reorganization chapter of the Code.  Chapter 7 is the straight liquidation chapter.  Chapter 13 is the wage-earner reorganization chapter.

Who is who?  The company that files (Chrysler) is the Debtor.  If the Debtor is still in control of its business (as in most Chapter 11 cases), it is called a Debtor-in-Possession or DIP.  The people who are owed money are called creditors.  The people (or companies) who own the debtor (stockholders or otherwise) are called interest holders.  The Judge is the Judge or the Court.  Everyone has a lawyer (or several).  In large and complex cases, the Court often appoints an Examiner (to investigate) or a Trustee (to examine and control).  If a Trustee is appointed, he or she takes control of the assets and the business.  The Debtor is then out of possession and is no longer a DIP.

Chapter 11 allows Court-supervised restructuring.  The Code permits the changing of contracts over the objection of the other parties.  Debts are contracts, supplier agreements are contracts, and dealer agreements are contracts, to name a few.  The Court supervises the process.  The parties (all of the stakeholders) all get to have their say and the Court tries to balance the interests under the Code.

Debts.  Debt comes in different flavors.  Senior (or secured) debt has the right to take specific assets if not paid.  This is similar to a home’s mortgage loan.  If property filed and perfected, the debt is secured.  Priority unsecured debt is that debt which has no right to specific property, but has been given priority under the Code.  Consumer deposits, wages, and some employee benefits are examples of things that get paid before other, regular, unsecured debt.  Non-priority unsecured debt would be things like amounts owed to suppliers for deliveries prior to the bankruptcy.  Since nothing is that simple, there are some supplier deliveries that are given priority under some circumstances.  Debts with no special treatment are referred to as general unsecured debts.

Administrative Debts.  The costs of running the Chapter 11 and the Company are usually entitled to a very high priority in a distribution.  These include expenses incurred in the ordinary course of business, as well as the professional fees of representatives of “official parties” in the case.  These include the lawyers, financial advisors, and investment bankers for the Debtor, any official committees, and any Trustee or Examiner.

Contracts.  If a contract has already been performed by one side or the other, the other party is just entitled to money and is a creditor.  If there is still something to be performed by both sides, then the contract is “executory.”  Unfulfilled orders and unexpired real estate leases are examples of executory contracts.  If the contract is an executory contract, then the Debtor often gets to decide if it wants to keep the contract or not.  This is known as “assuming” or “rejecting” a contract.  Generally, the Debtor gets to make this choice, subject to Court approval.  If the debtor’s decision unreasonably burdens the company (harming other creditors), the Court may not approve the decision.

Assuming or Rejecting a Contract.  If the debtor decides to assume the executory contract, it is usually required to cure any defaults and show that it can perform in the future.  The debtor then gets the benefits and burdens of that contract after the bankruptcy.  If the Debtor chooses to reject a contract, the other party may be entitled to damages, just as if the company had breached a contract outside of bankruptcy.  The damages are usually treated as pre-bankruptcy, unsecured debts and are added to the other debts of the Debtor.  Collective Bargaining Agreements (Union contracts) have additional protections, but can eventually be modified or rejected by the Debtor.

Sales of Assets.  Although unclear in the current stories about Chrysler, we are expecting a sale of some of the operating assets of the Debtor.  Section 363 of the Code allows the sale of assets free of liens of the secured creditors.  These sales are often referred to as a “363 Sale.”

Plan of Reorganization.  This is the Debtor’s proposed restructuring.  Everyone (and in this case that includes the government) gets to weigh in on the Plan and try to improve its respective position.  This is the document that says who gets what and what the company looks like when it comes out the other end of the bankruptcy.  Sometimes the Plan is negotiated before the bankruptcy case is filed and then the Plan is filed at or near the time when the bankruptcy petition is filed, along with the required approvals of creditors.  When that works, the case can be called a Pre-Pack or pre-packaged bankruptcy.  When it doesn’t work, the Court still considers the proposal of the creditors and decides if it meets the tests of the Code and can be approved.

Why couldn’t this be done outside of bankruptcy?  Outside of bankruptcy, all parties must agree to the change of contracts and debts.  In bankruptcy, the Court can bind reluctant arties under certain circumstances.  It is often hard to get unanimous consent in a class of creditors (like bondholders or trade vendors).  Chapter 11 allows the Court to force a treatment on a class when more than half the creditors voting and more than  2/3 of the amount of money voting, approves the treatment.  Sometimes the Court can approve a plan when even these tests aren’t met, but it requires a much more difficult burden n the Plan proponent.

Why is Chapter 11 so expensive?  Some say Enron will cost more than $1 billion in professional fees.  Lehman Brothers estimates run over $700 million.  The Debtor’s professional have to handle everything and fight with everyone.  Every official party (committee, Examiner, Trustee) has professionals that get paid by the Debtor and have to participate in every aspect of the case to make sure their constituency is represented.  So every time the Judge hears anything in the case, there are several (or dozens) of lawyers in the court getting paid by the Debtor. 

Why does it take so long?  They can be very complicated.  A company like Chrysler didn’t get created overnight and didn’t get into this mess overnight.  It can take month or years to figure out how to fix it or to unwind it if it can’t fixed.  The Code has reasonable time limits built in, but things can get messy.  If everyone agrees in a Pre-Pack, it can move through in 60 days or so.  Some large cases have.  Here, it is likely to take much longer.  Who knows?

What to expect?  Expect stories about how Chrysler can jettison dealer agreements (which it can), pay some suppliers and not others (which it can), close plants and end supplier relationships (which it can).  If there is a good restructuring plan which just needed the power of the Court to bind reluctant creditors, it might move pretty smoothly.  With Lenders being asked to write off billions of dollars, expect there to be some significant relocation.

This outline of the basic terms and concepts should help people to better follow the twists and turns.

(Submitted to the Post-Gazette in response to a recent article)

First the disclaimer:  I am a bankruptcy and creditors’ rights lawyer.  I generally represent vendors, lenders and creditors.  I have also helped a few companies reorganize in Chapter 11 bankruptcy.

People (media and otherwise) are wailing about how bankruptcy equates to shutting down.  Recently, the P-G had some consultants concluding that bankruptcy won’t do for automakers what it did for the steel industry.  Notably, there were no bankruptcy lawyers quoted in the article.  There is fear-mongering that bankruptcy will mean millions of jobs lost and thousands of businesses closed.  With respect to the Big Three, this couldn’t be farther from the truth.  It is extremely rare for a bankruptcy of a business this size to result in a total shutdown and liquidation.  Typically, if a company enters into a Chapter 11, it will be able to reorganize its business or become acquired by someone else who will run the business.  In both scenarios many employees keep their jobs and suppliers continue to sell product to the company.  Under a Chapter 11, there are some powerful tools which allow a Judge to terminate or change contractual relationships.  In particular, the bankruptcy judge can order the restructuring of labor contracts.  I suspect that this, in conjunction with the potential loss of shareholder value, is the driving force behind Congress’s desire to “bail out” the Big Three.  There are very powerful lobbyists on the side of the unions and major shareholders that are joining forces.  The problem as I see it, however, is that the American public is being misled about the effects of Chapter 11 bankruptcy.

Chapter 11 reorganization will not create investment and borrowing ability for the Big Three, but it can create an atmosphere to allow that investment or credit on terms that might interest investors and lenders.  Lenders are more willing to lend to a bankrupt company when they know the company’s “old” debt will be discharged and they see the company bringing costs under control.  This gives the lender confidence that its “new” loans will be repaid.  At the very least, it can allow public (government) money to be loaned, directly or through bank guarantees, on a priority basis and only after a change in the business model has been proposed and vetted.  Congress has recently asked the Big Three to provide it with a plan as to how they will restructure their business model in order to be profitable in the future.  The irony of this demand is that proposing a workable business plan is exactly what Chapter 11 requires.  The difference, however, is that in Chapter 11, the creditors, employees and shareholders get to vote on whether the plan is viable.  In Congress, it is only the politicians who get to vote. 

With or without reorganization in Chapter 11 bankruptcy, fixing the Big Three will not be easy.  Jobs will be lost and some supplier businesses will fail.  Those businesses will fail because they became dependent on an industrial model that was ill-conceived and is past its prime.  All else being equal, would we expect the government to bail out the buggy-whip maker when the horse-drawn carriage maker went out of business?  Would we have kept the carriage maker alive just to save the whip maker?  No, we would not.  Bankruptcy reorganization will allow the Big Three automotive companies to have a breathing spell to restructure their business models and create more competitive products.  For a better analogy than the article’s comparison to the steel industry bankruptcies, take a look at the airline bankruptcies of the past two decades.  The airlines operated on an outdated and unprofitable hub and spoke business model.  Bankruptcy afforded many of the larger airlines the opportunity to restructure labor agreements and reorganize more along the lines of low cost carriers such as Southwest.  Just as would happen in Detroit, the airlines kept operating in Chapter 11, suppliers kept selling goods and services, and most people kept their jobs.  Yes, there was pain, but the airlines are still operation, many of them profitable, and the American economy did not collapse.  Despite fear mongering that consumers won’t by cars produced by a company in bankruptcy, people kept flying on planes and racking up miles on airlines in bankruptcy.  NONE of the Big Three will file for Chapter 7 liquidation.  If you hear any politician, lobbyist or Detroit executive say that’s a likely result, tune them out because they are either ill-informed or not telling the truth.  Even if one of the Big Three did file for Chapter 7, some creditor would surely ask the Court to force it into a Chapter 11 and for the appointment of a Trustee to preserve the business operations as a going concern.  Actually, I am surprised securities litigation has not already been initiated against GM executives for making such reckless comments over the past days.

Bankruptcy is much more complex than Congress, the media and Big Three executives are telling the public, but on some level, it comes down to whether or not we can and should save a sick business (or 3 sick businesses).  Regardless of who is to blame for Detroit’s problems, not one person has said how giving them taxpayer money will solve any of their problems.  Bankruptcy is an option to facilitate a responsible and workable business plan.  It may not be the most ideal situation, but it is the best option we have.

Bankruptcy is not the ideal solution.  While the discharge of debt and the termination of contracts are powerful tools, they aren’t the “cure” for the sick business model.  That cure will have to occur through thoughtful change.  Closing the business is a change.  Figuring out  how to build a product that people want, at a price people will pay, would also be a change.  Bankruptcy can facilitate that kind of change, but bankruptcy is a means, not an end.