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 Lara Shipkovitz, Esq.

Recently in Pennsylvania a Westmoreland County Judge ruled that landowner gas leases need not have both parties signatures to be valid in Snyder v. Rex Energy., Case No. 09CI06332.  Local landowners brought suit against Rex alleging the company reneged on a deal to lease their properties for Marcellus Shale drilling.  Rex maintained the leases were unenforceable because they never signed the leases.  Accordingly, the Company argued no contract existed.  The landowners argued that a contract was entered when they signed the leases that were prepared by the company without making any changes to the lease; meaning, this constituted a valid acceptance of the terms offered by Rex.  Judge Caruso agreed stating that the leases, unlike those in other cases, did not contain the express requirement that the company sign them to be valid. The issue was considered early on in the pleadings and later, the parties settled.  Ultimately, Rex agreed to five year leases, including bonus payments and royalties for the landowners.   In light of the increasing rulings and considerations of Marcellus Shale issues, it is more than ever for a landowner to understand  his/her legal rights and obtain experienced counsel for any transaction affecting these rights.

 Check out our Marcellus Shale website and feel free to contact us (news@bernsteinlaw.com) if you have any questions.

by Kit F. Pettit, Esq.

With all of the types of business entities available to choose from when starting a new business, how do you know which business entity is best? There are LLC’s, LP’s, S-Corps and C-Corps, and each type of entity has its own advantages and disadvantages depending on a number of considerations. Some of the advantages and disadvantages are tax matters, asset protection, liability protection and transferability. Some of the considerations include the entity’s size, the type of business activity, desired governance structure and other business investment matters.

Typically, tax treatment is one of the most important factors in choosing the form of business entity. Among other things, one of the basics tax matters an entrepreneur should know when deciding which entity may best suit his or her business plan is that C-corporations are subject to double-taxation while S-corporations are generally not subject to the two layers of taxation. A new business owners should also be aware that limited liability companies and partnerships are flow through entities and the earnings of these types of entities are not subject to federal income tax, however, Pennsylvania treats all limited liability companies as corporations for capital stock taxes. There are numerous tax advantages and disadvantages for each type of entity and a skilled legal practitioner along with advice from an accountant can help an entrepreneur through this maze.

Once the entrepreneur is aware of the tax considerations, personal liability protection is often the next most important factor to consider. The various entities can have different liability shields. Careful planning and consideration should be given and knowledge of the statutory liability limitations is most important. For example, 15 Pa.C.S.A. § 1526 sets forth the statutory rules with respect to the personal liability of shareholders of a business corporation while 15 Pa.C.S.A. § 8922 provides the rules for personal liability of members and managers in partnerships and limited liability companies. Business trusts are governed by a different statute. 15 Pa.C.S.A. § 9506.

The governance structure and standards of conduct of the shareholders, partners or members is also a very important consideration when organizing and forming a new entity. The governance structure of each type of entity differs and there are business, legal and other reasons why an individual or group of individuals may prefer one management structure over another. In Pennsylvania, corporations have established governance principles and structural formalities that are for the most part defined by statute and case law. 15 Pa.C.S.A. § 1701 et al. Partnerships are primarily governed by contract between the partners, i.e., a partnership agreement, however, there are certain rights and duties of partners governed by statute. 15 Pa.C.S.A. §8331 et al. As for limited liability companies, they have significant flexibility with respect to governance of the company. For example, a Pennsylvania limited liability company can be “member-managed” which follows the general partnership rules, or it can be “manager-managed” which governance mechanism is most similar to that of a corporation. 15 Pa.C.S.A. § 8941.

The above matters highlight some basic and important considerations when starting a new business. Corporate formation and organization is more than an online “check-the-box” process. It takes knowledge and careful planning based on information provided by the client. For example, does a majority-member of a limited liability company really want unanimous consent provisions in the company’s operating agreement that would require the consent of a 5% member for certain company actions? Would you incorporate as an S-corporation if you anticipate distributions to some shareholders and not others? After all of the considerations have been discussed and the form of entity selection is made, an entrepreneur should also know that each type of entity has its own formation and organization requirements and respective formalities that should be properly observed and followed once incorporated or organized. Observation and practice of these important formalities such as annual meetings of members and shareholders is a part of the liability protection mechanism and should not be ignored or forgotten once your business is up and operating.

by Maribeth Thomas, Esq.

Alternate dispute resolutions such as mediation have become prevalent in bankruptcy proceedings and often result in much success for all parties involved. Mediation is not an official judicial proceeding and instead is designed to encourage collective agreement amongst parties to a dispute. The mediation process is informal and is most often entered into voluntarily by the parties.

In particular, mediation can be especially effective in Chapter 11 bankruptcies as a tool to construct a consensual plan of reorganization. The mediation process provides the debtor with an opportunity to negotiate, with the assistance of a neutral third party, with creditors in an informal setting to reach a settlement that is fair and in the best interests of all involved parties. Furthermore, by providing the debtor with an opportunity to resolve claims outside of court, both money and time can be saved by avoiding potentially expensive and lengthy litigation.

Mediation may also be useful in the chapter 7 context to resolve disputes involving preference, avoidance, non-dischargeability, fraudulent conveyance and claims allowance actions. Most recently, jurisdictions have implemented mediation procedures to prevent foreclosures. Such programs have been pioneered in Florida courts and require the debtor to file a chapter 13 bankruptcy. The programs work to reduce foreclosures by reducing monthly payments and, in certain instances, forgiving mortgage principal. Early statistics demonstrate that the programs created by bankruptcy courts are significantly more successful in stopping foreclosures than programs implemented in the state court system.

The Bankruptcy Court for the Western District of Pennsylvania has adopted mediation procedures as a method of dispute resolution under Local Rule 9019-2. General Court Procedure # 4 establishes the specific requirements and standards for the mediation process. While the court can direct a party to mediation, a party may request mediation from the court through a signed stipulation or by the filing of a motion. It is important to remember that the mediation process does not delay any other proceedings in the bankruptcy case. If the mediator assigned to the case requires compensation, such costs are usually shared between the parties involved in the mediation. Each party and its primary attorney, must be present at the scheduled mediation conference, as well as any other parties in interest whose presence is necessary for a full resolution of the matter. Importantly, all material, both oral and written, that is produced at a mediation conference is to remain confidential. However, any material presented at the conference that would otherwise be discoverable or admissible is not exempted from discovery in a court proceeding merely by its use in mediation. If the parties are able to reach a settlement through mediation, the mediator must submit a fully executed stipulation to the court within twenty days after the conclusion of mediation. If the mediation conference does not result in a successful resolution of the dispute, the matter proceeds as scheduled before the court. For a full description of the procedures for mediation before the Bankruptcy Court of the Western District of Pennsylvania, please refer to the court’s General Court Procedures which can be found on the court’s website: http://www.pawb.uscourts.gov/.

by Shawn P. McClure, Esq.

It is a very common situation for a creditor to be owed a large sum of money from a debtor who continues to operate by paying other creditors or parties. Naturally, this is very frustrating. It can also be very disturbing because at the same time there are rumblings of the debtor’s financial instability. At this point, the creditor must decide on a course of action.

Certainly, the creditor has the option of filing a state court breach of contract action and working toward obtaining a judgment. However, litigating a lawsuit takes time and even more time is spent to execute on the judgment. The passage of time affords the debtor the opportunity to continue paying others and ultimately wind down the business.

There is another option, which is often overlooked. Force the debtor into bankruptcy. This is done by filing an involuntary bankruptcy petition. The reason for an involuntary bankruptcy is to prevent and protect creditors from unfair activities and treatment by debtors. The greatest advantage to an involuntary bankruptcy is that it forces bankruptcy upon the debtor rather than allowing the debtor to ultimately file on its own terms. This is extremely important because of the ability to recover payments or wrongful transfers by the debtor within certain time frames leading up to the filing of the bankruptcy petition. These payments and transfers can be brought back into the bankruptcy estate to be properly distributed by the bankruptcy court.

In sum, bankruptcy is not always a bad thing for unsecured creditors. It just simply depends upon whose terms the bankruptcy is filed.

If you are interested in reading more about involuntary bankruptcy click here

by Shawn P. McClure

Once a claim goes legal, there are many factors that come into play and directly impact a creditor’s ability to get paid.  As a credit professional, you must be aware of these factors to determine their impact on settlement negotiations and how far you decide to push the debtor.  As a creditors’ rights attorney, we must be available to quickly identify how these factors impact litigation and provide our clients with intelligent insight as to how litigation is likely to play out in light of these factors.

The rules of evidence are such a factor.  All of a sudden the forwarded email from a cousin’s mother’s friend who used to work for the debtor may not make it to the trier-of-fact, let alone have the impact the creditor thought it would.   

In the typical creditor-debtor dispute, evidence usually translates to written documents (contracts, invoices, statements, correspondence etc.) setting forth the basis for the parties’ relationship.  As a result of being a simple man, I like to keep in mind three simple concepts when determining whether I can get documents into evidence.  Those concepts are:

1.       Relevance – Why does this matter?

2.       Authentication – Is this real?

3.       Hearsay – Is this reliable?

The first concept is pretty self explanatory and is often easily understood because it involves logic that makes sense to a layperson.  For example, my client’s contract with the debtor is relevant to the issue of whether or not money is owed to my client.  Whereas, my client’s lease with their landlord has no bearing on the issue. 

It is with issues of authentication and hearsay, that clients and attorneys spend an inordinate amount of time explaining to each other and arguing with debtor’s counsel.  I could write pages upon pages trying to explain these concepts, so I will leave you with three helpful tips.  The last being the most useful.  Pay attention to rules on self-authenticating documents to hopefully ease the burden on yourself.  Hearsay is an out of court statement offered for its truth, it remains hearsay even if the declarant is now on the stand during trial.  Lastly, evidence law is determined by the trial judge that you are currently practicing before.  

I would like to wrap up by sharing a recent experience that illustrates why it is important to keep evidence concepts in mind throughout the legal process. 

I recently had a case where debtor’s counsel filed preliminary objections in response to my client’s complaint.  Simultaneously, debtor’s counsel served discovery requests.  More specifically, debtor’s counsel served a request for production of documents seeking the original credit application that was alleged in the complaint.  Debtor’s counsel filed preliminary objections asking the court to dismiss the complaint because we failed to attach the original credit application to our complaint.  The basis for these objections being that the failure to attach the original credit application was a violation of the Best Evidence Doctrine.  Well, we didn’t have the original credit application.  We told debtor’s counsel we didn’t have it in our responses to discovery.  However, in deciding the preliminary objections, the judge correctly overruled the debtor.  As simple as it sounds, debtor’s counsel forgot one importance aspect of the Best Evidence Doctrine.  It doesn’t come into play until a party is trying to put evidence into the record at trial.   

As for how that case turned out at trial … it will probably settle soon.     

by Shawn P. McClure 

Under Pennsylvania common law, “the primary difference between a surety and a guarantor is the time at which a creditor can collect from each.  With regard to suretyship, the creditor can look to the surety for immediate payment upon the occurrence of a default by the principal obligor or debtor … However, where an individual is a guarantor, the creditor must first attempt to collect the debt from the principal debtor/obligor before demanding performance from the guarantor.”  Reuter v. Citizens & Northern Bank, 410 Pa.Super 199, 208, 599 A.2d 673, 678 (Pa. Super. 1991). 

Sounds troubling for a creditor.  After reading that statement, there is probably one question that quickly comes to mind.  What constitutes an “attempt?”  This question could be argued a hundred times over.  Thankfully, the Pennsylvania legislature has brought some clarity to this question. 

Under 13 Pa.C.S. § 1201, which is Pennsylvania’s codified version of the Uniform Commercial Code’s general definitional section, “[s]urety. Includes a guarantor or other secondary obligor.” 13 Pa.C.S. § 1201.  Thus, no “timing” requirement exists as to when a creditor can look to a guarantor for payment of a debt.      

Moreover, Pennsylvania statute provides that:                                                  

“[e]very written agreement hereafter made by one person to answer for the default of another shall subject such person to the liabilities of a suretyship, and shall confer upon him the rights incident thereto, unless such agreement shall contain in substance the words: “This is not intended to be a contract of suretyship,” or unless each portion of such agreement intended to modify the rights and liabilities of suretyship shall contain in substance the words: “This portion of the agreement is not intended to impose the liability of a suretyship.”

      8 P.S. § 1. See, also, Keystone Bank v. Flooring Specialists, Inc., 513 Pa. 103, 113, 518 A.2d 1179, 1184 (1986) (“section 1201 of the UCC is not the sole authority for treating a guarantor, especially where he has ‘guaranteed payment,’ as a surety.”).

      Accordingly, where Pennsylvania law applies, a creditor with adequately drafted documents does not have to first look to the principal debtor/obligor for payment before pursuing a guarantor.