by Scott Schuster, Esq.

According to a recent article in the New York Times, individual and corporate bankruptcies are at a five-year high. As a creditor, here are three things to keep in mind during these difficult financial times:

1)      With the increase in “under water” secured creditors, unsecured creditors are receiving less and less on their claims through bankruptcy. It may be a good idea to have a backup if a customer fails to pay its bills. Letters of credit, lien rights, and partial payments on delivery are all ways to mitigate the damage that can be caused by a failing customer’s bankruptcy.

2)      Just because a customer has always paid its bills in the past does not mean it will do so in the future. Increasingly, even healthy companies are struggling financially. Keep an  eye on credit terms that you extend to all of your customers, both big and small. It never hurts to reevaluate the terms on which you extend credit to your largest customers. If you conduct a credit worthiness analysis and find something troubling, it may cause you to take additional action to protect yourself from unpaid bills. If the credit check reveals no problems, at least you can sleep soundly knowing that those customers are healthy enough to pay their bills in the future.

3)      Preference actions are on the rise. Debtors and trustees are looking to preference actions as a means to fund distributions to unsecured creditors. This means creditors should be aware of the defenses to those actions and should review their “danger” clients to make sure that payment times are not getting too high. Ideally, payments should be made within (or very close to) payment terms (“NET 30,” etc.). If customers are not doing so, it may be prudent to limit the amount of credit that you extend now to protect yourself from a preference action in the future.

by Scott Schuster, Esq.

Unfortunately, the Code does not require that the administrative claim be paid in full immediately after the Court allows the claim. Instead, the Code only sets the relative priority of the claim.  In Chapter 11, a requirement for the confirmation of a Plan is that administrative expense claims be paid “in full and in cash.” If the case is ultimately declared “administratively insolvent” – i.e. the debtor does not generate sufficient cash to pay its administrative claims – then 503(b)(9) creditors will probably not receive the full amount of their claims.

While the court can order immediate payment of these claims, they often decline to do so. The courts have tended to be very debtor friendly on this issue. In two recent cases, In Re Bookbinders and In Re Global Home Products, LLC, creditors attempted to force immediate payment of 503(b)(9) claims. In both cases, creditors urged the court to order immediate payment of the claims, arguing that there may not be enough assets left at the end of the bankruptcy to pay the 503(b)(9) claims in full. In both cases, the courts’ reasoned that the Code did not explicitly provide for immediate payment. The courts in both cases denied the creditors’ request for immediate payment of their 503(b)(9) claims. Unfortunately, in the Global Home Products case, 503(b)(9) creditors ultimately received less than 50 percent of their claims under the debtor’s Plan.

While a 503(b)(9) creditor appears to face an uphill battle, it is not all bad news. In fact, section 503(b)(9) has greatly increased the potential for recovery for large numbers of unsecured creditors nationwide. Notwithstanding the difficulties of allowance and payment that 503(b)(9) creditors face, they stand in a better position than a general unsecured creditor. Section 503(b)(9) claims are given the same priority status as the debtors’ attorneys’ and other professionals’ fees. In the grand scheme of the bankruptcy system, this is about the best position in which a trade creditor can sit.

Since many 503(b)(9) motions are lightly contested, they can be handled by experienced creditors’ rights counsel at a modest price. In fact, a valid 503(b)(9) claim is often stipulated to by the debtor early in the case. Often the debtor will agree to allow the claim in full, if the creditor agrees to forego payment until a plan can be confirmed. This system benefits all parties because if all 503(b)(9) creditors demanded immediate payment in full, many debtors would not have sufficient cash flow to meet those demands, and would terminate operations shortly after entering bankruptcy. Since debtors rarely enter bankruptcy with significant cash reserves, such an outcome would likely result in 503(b)(9) creditors receiving far less than 100 percent of their claims.

If a creditor is willing to accept a reduced amount on its 503(b)(9) claim, then it should consider “claim traders” – companies that purchase bankruptcy claims from creditors. Claim traders are often very interested in 503(b)(9) claims and, depending on the circumstances of the particular debtor and its prospects for reorganizing, are often willing to pay a very large percentage of the claim.

by Shawn P. McClure, Esq.

So you’ve met with an attorney and you have been informed that you have a “strong” case. Of course you instruct your attorney to immediately run to the nearest courthouse and file a writ, summons, complaint or whatever legal document is necessary in order to immediately get the ball rolling. In the words of a certain sports broadcaster on crisp fall mornings, “Not so fast my friend!”¹

Almost as important to the determination of whether or not you have a factual basis for a lawsuit, is the decision of what court to file that lawsuit in.² However, before narrowing in on a particular court, there is the question of what type of court you will file in.

Our country has a dual court system; we have both state and federal courts. Generally, the difference between the two court systems boils down to jurisdiction. Jurisdiction is a court’s ability to hear a particular matter. State and local courts are, for the most part, courts of general jurisdiction with the ability to hear almost every type of dispute. Federal courts are established under the U.S. Constitution for the purpose of deciding disputes involving the Constitution and laws passed by Congress. However, there are certain scenarios where a particular matter may fall within both the jurisdiction of the state and federal court systems.

For the entire article please visit: http://www.bernsteinlaw.com/publications/021810_1.htm and tell us what you think.

By Scott E. Schuster, Esq.

I read this article in the Pittsburgh Tribune Review:(http://www.pittsburghlive.com/x/pittsburghtrib/news/s_672744.html) and it got me thinking about state oversight of financially distressed municipalities. Under Pennsylvania state law (commonly referred to as Act 47), municipalities in the Commonwealth are not eligible to file for federal bankruptcy protection without first implementing a financial recovery plan overseen by a state appointed board.

This approach to municipal reorganization stands in stark contrast to the federal bankruptcy code. Under the state law, a distressed municipality attempts to cut expenses and increase revenue in an effort to pay off its debts. The result is often a myriad of political “quick-fixes,” such as new taxes, elimination of social programs, and the sale or lease of municipal assets, such as parking garages.

The state system lacks two significant components that the bankruptcy code provides to distressed companies or municipalities to assist in reorganization. First, Act 47 does not allow for the discharge of debts. Instead, Act 47 requires that the municipality attempt to restructure certain debts or pay them off with a lump sum. Of course, financially distressed municipalities usually lack the cash flow to make lump sum payments on large debts. Similarly, Act 47 does not allow municipalities to cancel unfavorable contracts. The inability to discharge debts and cancel unprofitable contracts would have proven fatal to several big companies that have emerged from Chapter 11 Bankruptcy over the past two decades; GM, US Airways, and the Pittsburgh Penguins, just to name a few.

Second, the Bankruptcy Code gives corporate debtors the ability to “cram down” union contracts for the best interest of all creditors. In other words, the Bankruptcy Code allows union contracts to be reasonably restructured so that the company’s employees do not sap all of the company’s future revenue, leaving nothing for creditors. Act 47 system has no such provision and, in fact, relies exclusively on the political leaders of the municipality - often unions’ closest allies - to enact changes in applicable collective bargaining agreements. Such a system is destined to fail and has done so, repeatedly.

The Tribune Review reports that 25 municipalities have entered Act 47 oversight but only 6 have escaped. Proof of Act 47’s shortcomings can be seen right here in Pittsburgh, which was forced into this state form of receivership in 2004 and has spent nearly 6 years attempting to right its financial ship, but to no avail. As of this writing, Pittsburgh’s employee pensions have only 30% of the money necessary to fund future payouts. Unions have refused to agree to reduce their benefits and the politicians responsible for forcing such concessions lack the political backbone to press for change. In short, politics has taken over and, 6 years later, the City is still on the verge of bankruptcy. How has Act 47 helped the City of Pittsburgh? It hasn’t.

With the economic downturn and lack of revenue, more and more municipalities in Pennsylvania are at risk of falling into Act 47 protection. Those municipalities are staring at five to ten years of financial purgatory, during which no meaningful changes take place and bankruptcy continues to loom on the horizon. I say let Pennsylvania municipalities file bankruptcy.

by Scott Schuster

There is perhaps nothing more frustrating than when one of your customers files bankruptcy and avoids paying money that they owe your company. However, anyone that has dealt with a “preference action” knows that merely writing off a debt as uncollectible is not the worst thing that can happen when a customer enters bankruptcy. A preference action has the potential to be much worse, because it is a lawsuit by the debtor or the bankruptcy trustee against your company, seeking to recover payments that were made by the debtor to your company before the bankruptcy. Fortunately, the Bankruptcy Code provides creditors with certain defenses that can be used to defeat a preference action.

The Bankruptcy Code permits the trustee to avoid and recover from creditors payments made within the 90-day period before the bankruptcy filing. The policy behind this provision is to prevent aggressive collection activities that often force the debtor into bankruptcy. 

A “preference” is defined by Section 547 of the Bankruptcy Code as:

1. Payment on an “antecedent” (meaning a previously incurred as opposed to current) debt;
2. Made while the debtor was insolvent (meaning its assets are less than its liabilities);
3. To a non insider creditor, within 90 days of the filing of the bankruptcy;
4. That allows the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding.  

Section 550 of the Bankruptcy Code allows the trustee to avoid and recover any preference payments by filing a lawsuit against the creditor.

Typically, a preference action is often preceded by a “demand letter” from the debtor or the trustee. The demand letter sets forth the trustee’s claims and demands immediate payment. Often times the trustee is willing to settle the preference action for an extremely reduced amount if the settlement is reached before the lawsuit is filed. Consequently, when the creditor receives a “preference demand letter,” the creditor should always have experienced bankruptcy counsel review the case to determine whether the creditor has valid defenses. Bankruptcy counsel can often negotiate a favorable settlement and allow the creditor to avoid having to expend large sums of money in litigation.

If the parties do not reach a settlement, the preference action is initiated with a complaint filed with the bankruptcy court. The preference complaint is similar to any other lawsuit with the exception that its filed in bankruptcy court, rather than federal district or state court.

Many bankruptcy attorneys are concerned about the efficiency of their process. By definition, at least the debtor has limited funds to pay for an engagement. This impacts the creditors who may not see a full recovery on their claim. As a result, many bankruptcy practitioners are leery of spending any resources on electronic discovery. This podcast was created to share the experiences of Bob Bernstein, a bankrupcty practitioner in Pittsburgh, PA with Bernstein Law Firm and Jeffrey Ritter, an electronic discovery consultant from the Waters Edge who has just written a book on electronic discovery and the bankruptcy process called Discovering the Digital Record-The Questions for Examination. 

Click link to listen to Podcast: http://www.esibytes.com/?p=718

Click on this link to see Bob Bernstein talk with Kevin Miller on WPXI’s NightTalk about Bankruptcy and Get P.A.I.D.: A Guide to Getting Paid Faster (and What to do if You Don’t!)

http://www.youtube.com/watch?v=vsgGf2RIig4

Please feel free to share this link with people.

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.