Transcript Document

Corporate Bankruptcy 101 &
Select Bankruptcy Issues
Morris S. Bauer, Esq.
Andrew Stein
Larry K. Lesnik, Esq.
The material provided herein is for informational purposes
only and is not intended as legal advice or counsel.
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2
LOOK OUT!
Bankruptcy Filings On The Rise
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The Economic Indicators
Unemployment, Interest Rates, Housing
Market (Foreclosures), Stock Market,
Consumer Spending,Bad Credit-Card Debt
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Factors Leading to
Financial Distress
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Liquidity Crisis
Asset-Based Loan Default
Loss of Major Client/Customer
Loan Maturity and Unable to Refinance
Drop in Revenue
Increased Operating Costs
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The Chapters Of Bankruptcy
Chapter 7
Chapter 9
Chapter 11
Chapter 13
Chapter 15
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Utilization of the Chapter 11
Process
• Reorganization
• Sale as a Going-Concern
• Orderly Liquidation
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Who Can File a Chapter 11
Businesses
Corporations, Limited Liability
Companies, Partnerships
Individuals
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Commencement of a
Chapter 11 Case
• Minimum Documents Necessary to File a Case:
– Petition, Corporate Resolution, Creditor List, List of Twenty
Largest Unsecured Creditors, and List of Equity Interest
Holders
• Timing:
– Minutes With the Advent of Electronic Filing
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Commencement of a
Chapter 11 Case (Cont.)
• Notice to Creditors:
– Twenty Largest Will Receive Notice Within
a Day of the Commencement Date (If
Emergent First-Day Hearings Are
Requested)
• Other Creditors Will Receive Notice
Within Approximately Two Weeks
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Commencement Of a
Chapter 11 Case (Cont.)
• Effect of Filing:
– Automatic Stay (Section 362 of the
Bankruptcy Code)
– Requirement for Court Approval of Any
Action Outside of the Ordinary Course of
Business
– Jurisdiction of Court Over Debtor’s Assets
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The Players
What is a Debtor-in-Possession?
My company is losing money. I get to stay
in control and keep collecting the same
compensation. What more can I ask for?
Yippee!
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Debtor’s Professionals
Who are they?
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Counsel
Special Counsel
Chief Restructuring Officer
Accountants
Investment Bankers
Environmental Engineers
Brokers (real estate or business)
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Debtor’s Professionals
How are they retained and how
do they get paid?
Retention Requirements
Compensation
(No such thing as a free lunch!)
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United States
Trustee’s Office
• Role: Monitoring Chapter 11 Cases
– Conducting Committee Formation Meeting
– Conducting Meeting of Creditors
– Professional Retention and Fee Application
Oversight
– Quarterly Fees
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Types Of Creditors
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Banks (Pre-Petition Lenders)
Equipment Lessors
Landlords
Trade Payables
Taxing Authorities (Priority Claim)
Priority Claims (Wages, Commissions,
Benefits, including Union Claims)
• Equity Holders (Shareholders)
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Creditors’ Committee
• Formation Process
• Role of Committee
• Committee
Professionals
• Compensation of
Committee
Professionals and
Committee Members
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Types of Notices Mailed to
Creditors
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Committee Formation Meeting
First Day Motions to Largest Unsecured Creditors
Notice of the Section 341 Meeting
Notice of Bar Date Along With a Proof of Claim Form
Notice of Sale of Assets
Notice of Settlements/Abandonment
Notice of Professional Fee Application Hearings
Notice of Disclosure Statement Hearing
Notice of Plan Confirmation
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Representation of Creditors
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In-House Monitoring of
Chapter 11 Cases
 Centralized Mailing Address for Bankruptcy Notices
 Bankruptcy Department to File Proofs of Claim, Note Important
Dates, and to Receive Any and All Bankruptcy-Related
Documents
 Outside Counsel
 Forms and Letter Responses
 Proof of Claim Form
 Reclamation Demand Letter
 Response to Preference “Dunning” Letters
 Basic Knowledge of Preference Defenses
 Bankruptcy Rights With Respect to Contracts with Debtor
 Access to Pacer
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General
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Doing Business With a Debtor
Filing a Notice of Appearance
Serve Reclamation Demand, if Applicable
Adhere to the Deadline for Filing Proof of
Claim
• Analyze Potential Preference Exposure
• Be Cognizant of the Debtor’s Viability and
Continuing Operations
• Motion Objecting to Claims
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Should I Continue to Do
Business With a Debtor?
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Access to Financial
Information of Debtor
Business Terms
Administrative Expense Claim
Emotions v. Profit
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Available Information
• Schedules of Assets and Liabilities and
Statement of Financial Affairs
• Monthly Operating Reports
• Counsel to Creditors Committee
• Other Creditors
• The Web (Newspaper Articles, etc.)
– Court’s Website – Pacers
– Newspaper Articles, ect.
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Reclamations
 Administrative Claim – Automatic Administrative Claim for any
goods received by the Debtor within 20 days prior to the Petition
Date.
– Bar Date for filing Administrative Claim
– Motion to Compel Payment of Administrative Claim
 Reclamation Demand - Within 20 days of the Petition Date,
Creditor may serve demand on the Debtor for the return of
goods received by the Debtor within 45 days prior to the Petition
Date.
 Defenses to Reclamation Demand
– Subject goods no longer in possession of Debtor as of the
Petition Date
– Lender with a Lien on all Inventory, including subject goods
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Claims Process
• Bar Date (Deadline to File a Claim)
• Filing a Proof of Claim
• Motion Objecting to Claims
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Claims Trading
• What is it?
• Benefits of Selling Claim
• Risks of Selling Claim
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BANKRUPTCY
CLAIM TRADING
Andrew Stein
General Attorney, AT&T
Bankruptcy claims are like junk in the attic.
Which makes more financial sense – donating what
you have to charity for a tax deduction, or trying year
after year to sell it for pennies on the dollar at a
garage sale?
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REMEMBER!
You may not write off an account automatically just
because your customer has entered bankruptcy.
For claims that are more than de minimus, the IRS
requires objective evidence of worthlessness to
support a full or partial write-off.
In a bankruptcy, such objective evidence is usually
not available early on.
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IN A BANKRUPTCY CLAIM SALE,
THE BUYER AND SELLER BOTH STAND TO WIN
THE BUYER gets an opportunity to realize a healthy
return on a cash investment.
THE SELLER gets instant cash and an accelerated
tax benefit that the IRS is not likely to challenge.
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SELL OR HOLD?
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ASSUMPTIONS
$500,000 claim
14% cost of capital
40% effective tax rate
No objective evidence of worthlessness until the final
year of the bankruptcy
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Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000
Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000
Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000
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Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000
Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000
Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000
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Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000
Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000
Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000
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Sell for 2% in 2009? $206,000
Hold for 20% recovery in 2011? $200,000
Sell for 20% in 2009? $260,000
Hold for 60% recovery in 2012? $256,000
Sell for 1% in 2009? $203,000
Hold for 10% recovery in 2010? $202,000
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CONTRACT
SELLER
Assumes risk that claim is valid
BUYER
Assumes risk of percentage payout
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Preference Actions
Adding Insult to Injury
• Preference Payments – Typically, any payment
received within 90 days of the Petition Date
• Dunning Letter from Debtor or Liquidating Trustee’s
Counsel
• Defenses
– Contemporaneous Exchange
– New Value
– Ordinary Course of Business or financial affairs of
the debtor and the transferee or made according
to ordinary business terms
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Personal Injury Claimants
• Automatic Stay Stops Litigation
• File Motion for Stay Relief to Seek
Recovery from Insurance Carrier
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Executory Contracts
• An Executory Contract is a contract in which both
parties still have continuing obligations
• Examples: Residential or Commercial Leases,
Certain Equipment Leases, Service Contracts,
License Agreements, and Collective Bargaining
Agreements
• A non-Debtor party is required to continue with
performance under the contract
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Executory Contracts (Cont.)
• Assumption/Rejection of a Lease
• Motion to Compel Assumption or Rejection
• Bankruptcy Code provides Debtor with a 120day period to decide to assume or reject a
non-residential lease, which period can be
extended for an additional 90 days thereafter
and further if consented to by the landlord.
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Landlords
• Debtor must assume or reject NonResidential Lease within 210 days
unless Landlord consents to further
extension
• Debtor required to make all lease
payments in accordance with lease
terms
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Landlords (Cont.)
• Motion to Compel Assumption
• Relief From Stay to Terminate Lease
• Motion Seeking Adequate Protection
Payments
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Landlords (Cont.)
• Assumption of Lease
– Adequate Assurance of Future Performance
– Cure of Any Arrearages
• Assignment of Lease
– Adequate Finances of Assignee
– Shopping Center Leases
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Equipment Leases
Equipment Financing
• True Lease vs. Disguised Security
Interest
• Motion for Stay Relief
• Motion for Adequate Protection
• Assumption of Lease
• Sale of Equipment
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Time Line of A Chapter 11 Case
First Day Motions
• DIP Financing/Use of Cash Collateral
• Financial Reporting
• Sale or Liquidation of Business
• Plan of Reorganization/Plan of Orderly
Liquidation
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First Day Motions
“I filed Chapter 11 and I am now told I
can’t pay anyone (including employees)
until the Court says I can. What is the
delay?”
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First Day Motions (Cont.)
• Use of Cash Collateral or Debtor-inPossession Financing
• Payment of Wages and Other Employee
Benefits
• Customer Refunds and Rebates
• Pre-Petition Critical Vendors
• Payment of Sales, Use and Other Taxes
• Maintaining Cash Management Systems
• Utility Companies
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First Day Motions (Cont.)
Who is Served?
How quickly does the Court hear the
Motions?
Can they be opposed?
What is the likelihood of the Court
denying the Debtor’s requested relief?
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DIP Financing vs. Cash Collateral
What is Cash Collateral?
What is DIP Financing?
How are creditors affected by DIP Financing
versus Cash Collateral?
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Financial Reporting
• Schedules of Assets and Liabilities and
Statement of Financial Affairs
• Budget for Use of Cash Collateral and DIP
Financing
• Monthly Operating Reports
• Disclosure Statement Provides Historical
Financial Information and Forecasts
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Sale of Assets in a
Chapter 11 Case
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Types of Sales
• Asset Sale vs. Stock Purchase
• Section 363 vs. Plan of
Reorganization
• Higher and Better Offers
• Secured Creditor Sale/Foreclosure
Sale
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Chapter 11 Bankruptcy Sale
Process
• Retention of an Investment Banker/Business
Broker
• Motion to Fix Bidding Procedures
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Bidding Procedures Hearing
Standard Asset Purchase Agreement
Stalking Horse Agreement
Break-Up Fees
Minimum Bids/Overbid
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Impact of a Chapter 11 Sale
• Sale Free and Clear of All Liens, Claims and
Encumbrances
– Successor Liability
• Assumption and Assignment of Executory
Contracts
– Payment of Arrearages
– Adequate Assurance of Future Performance
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Plan of Reorganization and
Disclosure Statement Process
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Exclusivity
The Debtor has the exclusive right to file
a plan for a period of 120 days, which
may be extended up to 18 months.
Competing Plans – Plan filed by Creditors
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Plan Negotiations
• Treatment of Secured Creditor, who is
primary lender to the Debtor
• Negotiations with Creditors’ Committee
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Plan Negotiations from
Committee Stand-Point
• Is the Debtor viable?
• What would unsecured creditors receive in a
liquidation?
• Are there claims against Insiders (leverage)?
• Are there claims against the Lenders, i.e.
lender liability (leverage)?
• Are there avoidance claims against vendors?
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Plan of Reorganization
• Contents of Plan
• Classification of Claims
• Treatment of Claims
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Disclosure Statement
• Content: Similar to a Prospectus
• Provide Sufficient Information for a
Reasonable Person to Vote on the Plan
• Notice of Disclosure Statement Hearing
• Objections to Disclosure Statement
• Approval of Disclosure Statement
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Requirements for Approval of
Plan of Reorganization
• Consent of Impaired Classes of Creditors
• Fair Treatment of Creditors
– Class of Creditors Must Receive More Than What
They Would Receive in a Liquidation
– Absolute Priority Rule -Junior Class of Creditors
Cannot Receive Anything Until the Senior Class of
Creditors is Paid in Full Unless Senior Class Consents
– New Value
– LaSalle – Is Equity Paying Fair Value to Retain
Ownership?
• Feasibility
• Cram-Down
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Plan of Orderly Liquidation
• Contents of Plan and Approval Process
• Liquidation Trust
• Assets Available for Unsecured Creditors
– Remaining Sale Proceeds, if any
– Preference Actions
– Other Causes of Action
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Questions and
Answers
Lunch Break
12:00 pm – 1:00 pm
Corporate Bankruptcy 101 &
Select Bankruptcy Issues
Ilana Volkov, Esq.
Melissa A. Peña, Esq.
James N. Lawlor, Esq.
Joseph Aronds, Esq.
The material provided herein is for informational purposes
only and is not intended as legal advice or counsel.
Key Considerations For Landlords
When Faced With Commercial
Tenant’s Bankruptcy
Presentation to New Jersey Corporate
Counsel Association
March 24, 2009
Ilana Volkov, Esq.
[email protected]
(201) 525-6269
Automatic Stay –
Sections 362 and 541
Section 362(a) of the Bankruptcy
Code prevents actions by landlords to
obtain possession or exercise control
over property of the estate.
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Automatic Stay – Sections 362
and 541 (cont’d)
• Landlords must obtain relief from the
automatic stay before taking any action
against the bankrupt tenant or its property.
• Conversely, the automatic stay does not
apply to any act by a lessor to obtain
possession of the property covered by a
lease that has terminated before the
commencement of the bankruptcy case.
• A lease may be terminated by its own terms
or, in New Jersey, upon issuance of a
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Judgment for Possession.
Ipso Facto Clauses – Section
365(e)
• Ipso facto clauses permit nondebtor counter-party to terminate
the contract or lease in the event
of bankruptcy.
• Ipso facto clauses are not
enforceable.
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Payment of Post-Petition Rent –
Section 365(d)(3)
• Landlord entitled to timely payment of
post-petition lease obligations until
such time as lease is rejected or
assumed.
• Debtor’s obligations to pay lease
obligations after the bankruptcy filing
constitutes an administrative expense
of the bankruptcy estate under Section
503(b).
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Payment of Post-Petition Rent –
Section 365(d)(3) (cont’d)
• The lease will govern what
constitutes “rent.” To the extent so
provided in the lease, “rent”
includes rent, taxes, insurance,
and CAM charges.
• “Stub” rent: “billing date” v.
“accrual method” approach.
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Assumption of Leases – Section
365(b)
If a tenant opts to assume the lease, it must:
(1) cure or provide adequate assurance that it will
cure defaults under the lease, including defaults
related to non-monetary obligations under the
lease;
(2) compensate or provide adequate assurance that it
will compensate the landlord for any actual
pecuniary loss to the landlord resulting from the
defaults; and
(3) provide adequate assurance of future
performance under the lease.
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Special Rules for Assumption of
Shopping Center Leases – Section
365(b)(3)
What is a “shopping center”?
• In re Joshua Slocum Ltd., 922 F.2d
1081, 1087 (3d Cir. 1990).
• The Bankruptcy Code contains special
rules for the assumption and
assignment of shopping center leases
in its prescription of what constitutes
“adequate assurance of future
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performance”.
Rejection of Commercial Leases
– Section 365(a), (g)
• If lease not formally assumed, it is
deemed rejected by operation of law.
Alternatively, tenant can formally reject
the lease, subject to bankruptcy court
approval.
• Rejection is the equivalent of a
breach, deemed to occur on the
petition date. Section 365(g).
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Calculation of Rejection Damages Section 502(b)(6)
If lease is rejected, landlord has a
general unsecured claim for damages,
subject to a cap.
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Calculation of Rejection Damages Section 502(b)(6) (cont’d)
The cap limits the landlord’s damages claim to:
A. The rent reserved by such lease, without
acceleration, for the greater of one year or 15
percent, not to exceed three years, of the
remaining term of such lease, following the earlier
of:
i. the date of the filing of the petition; and
ii. the date on which such landlord repossessed,
or the tenant surrendered, the leased property;
plus
B. Any unpaid rent due under such lease, without
acceleration, on the earlier of such dates. Section
502(b)(6).
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Calculation of Rejection Damages Section 502(b)(6) (cont’d)
• Split of authority exists as to whether
“rent reserved” concept includes (and,
therefore, caps) other costs incurred
by landlord, such as repair and
maintenance.
• Duty to mitigate damages. In New
Jersey, commercial landlords have a
duty to mitigate their damages.
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Calculation of Rejection Damages Section 502(b)(6) (cont’d)
• Landlord may use security deposit
to offset total amount of lease
rejection damages.
• Relief from the automatic stay is
needed to set off a security
deposit post-petition, except if
security deposit took the form of a
letter of credit.
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Filing Proofs of Claim
• A chapter 11 petition commenced
solely to cap a landlord’s claim for
breach of a commercial property lease
may be dismissed under appropriate
facts and circumstances. In re
Integrated Telecom Express Inc., 384
F.3d 108, reh’g denied, 389 F.3d 423
(3d Cir. 2004)
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• Rejection of assumed leases
Timeline for Decisions Regarding
Assumption or Rejection – Section
365(d)(4)
• Tenants have 120 days from the
bankruptcy filing to assume or reject
the lease, although that deadline can
be extended for another 90-days.
• Tenant must show “cause.”
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Assignment of Leases to Third
Parties – Section 365(f)
Tenant can assign lease to third party so
long as:
1. The tenant assumes the lease in
accordance with Section 365(b) and
2. The assignee provides adequate
assurance of future performance
regardless of whether there has
been a default.
82
Assignment of Leases to Third
Parties – Section 365(f)
• Anti-assignment clauses generally are not
enforceable, where they are designed only to
impair the debtor’s ability to assume the lease.
• Assignment relieves the estate of future liability
under the lease. Section 365(k).
• If lease is assigned, lessor may require a deposit
or other security for the performance of the
debtor’s obligations under the lease substantially
the same as would have been required by the
landlord upon the initial leasing to a similar tenant.
Section 365(l).
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Avoidance Action Issues –
Section 547(b) and (c)
• If a landlord is sued for the recovery of
preferential payments made before the
tenant’s bankruptcy filing, the landlord could
avoid liability if payments were made in the
ordinary course of business.
• Additionally, if the lease ultimately is
assumed, the pre-petition payments cannot
be claimed as a preference.
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Lease Auctions and Designation
Rights
• Before BAPCPA and the collapse of the
economy, debtors routinely used lease
auctions and designation rights sales to
produce revenue for the estate, despite stiff
opposition from landlords.
• Designation rights purchaser usually does
not become the assignee under the lease.
Once the assignee is identified, the debtor
and assignee would have to demonstrate
that Section 365(c) is satisfied.
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Intellectual Property Licensing
Agreements and Bankruptcy
Executory Contracts
• A contract on which material performance
remains due on both sides.
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IP Licenses
• Generally, courts have found that
Intellectual Property Licenses are
executory contracts as of the date a debtor
files for bankruptcy when there are various
future performance obligations owed by
licensor and licensee.
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Intellectual Property
• Under Section 101(35A) of the Bankruptcy Code, intellectual
property is defined as
(A) trade secret;
(B) invention, process, design, or plant protected under title 35;
(C) patent application;
(D) plant variety;
(E) work of authorship protected under title 17; or
(F) mask work protected under chapter 9 of title 17 to the extent
protected by applicable non-bankruptcy law.
11 U.S.C. §101(35A).
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Exclusions to Definition of
Intellectual Property
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Trademarks
Trade names
Service mark licenses
Foreign Patents and Copyrights
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What happens when you are a licensee of
intellectual property and the licensor files for
bankruptcy?
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• Section 365(n) of the Bankruptcy Code
provides the licensee of an intellectual
property license with protection.
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Pre-Rejection Period
What can you do prior to the Debtor’s decision to assume
or reject the licensing agreement?
 Under Section 365(n)(4) of the Bankruptcy Code, you
can request that the Debtor continue to perform under
the license pending the Debtor’s decision to assume or
reject.
 The statute requires the Debtor to perform OR turn over
to the licensee the licensed property AND not interfere
with the licensee's rights under the license, including the
right to obtain the intellectual property (or embodiment)
from a third party.
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Post-Rejection Period
• Termination - Once the Debtor rejects the
license, the licensee can treat it as terminated.
• Licensee can now cease performance.
• Entitled to a general unsecured claim.
• ** Pre-Bankruptcy Planning – Since it will be
difficult to determine the amount of damages,
the license should be drafted to include a
liquidated damage clause.
94
Post-Rejection
•
Under Section 365(n)(1), the licensee can elect “to
retain its rights (including a right to enforce any
exclusivity provision of such contract, but excluding
any other right under applicable law to specific
performance of such contract) under such contract and
under any supplementary . . . as such rights existed
immediately before the case commenced, for –
(i) the duration of such contract; and
(ii) any period for which such contract may be extended by
the licensee as of right under applicable nonbankruptcy law.
11 U.S.C. § 365(n)(1)(B)(i) and (ii).
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Post-Rejection
• ** Pre-Bankruptcy Planning – Drafting
Acknowledgment of Subject Matter as
Intellectual Property and Applicability of
Section 365(n).
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Post-Rejection
• So you elected to retain the IP rights – now
what?
– Under Section 365(n)(2)(B) of the Bankruptcy Code,
the licensee has to make all royalty payments for the
duration of the license and any extension period.
– Under Section 365(n)(2)(C) of the Bankruptcy Code,
the licensee is deemed to have waived any right to
setoff and any administrative claim arising from
performance of such contract.
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Post-Rejection
• ** Pre-Bankruptcy Planning – Drafting
Define royalties narrowly.
98
Alternative Transaction Structures to
Minimize Bankruptcy Impact
• Excluding Intellectual Property from
Property of the Bankruptcy Estate
– As set forth in Section 541 of the Bankruptcy
Code, the commencement of a bankruptcy
case creates an estate which consists of all
legal or equitable interest of the Debtor in
property, wherever it is located, as of the
commencement of the case.
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Vehicles to Exclude IP from the Estate
• (1) Assignment of Intellectual Property
• (2) IP Trusts
• (3) Bankruptcy Remote Entities
100
Security Interest in IP
• Serves as a disincentive for the Debtor to
reject the license.
• May be particularly helpful with Trademark
Licenses.
101
Debtor is the Licensee
Can the Debtor assume and assign the
license agreement?
102
The Exception
• Section 365(c)(1) of the Bankruptcy Code states that:
The trustee may not assume or assign any executory contract . . . of
the debtor, whether or not such contract or lease prohibits or
restricts assignment of rights or delegation of duties if– (1)(A)
applicable law excuses a party, other than the debtor, to such
contract or lease from accepting performance from or rendering
performance to any entity other than the debtor or the debtor in
possession, whether or not such contract or lease prohibits or
restricts assignment of rights or delegation of duties; and (B) such
party does not consent to assumption or assignment . . .
11 U.S.C. § 365(c)(1)(A) and (B) (emphasis added).
103
Can there be an assumption or
assignment under non-bankruptcy law?
•
Patent Licenses
– Courts have found that patent licenses cannot be assumed or assigned by a
debtor under Section 365(c)(1) of the Bankruptcy Code as federal law prohibits
the assignment of a non-exclusive patent license without the consent of the
licensor.
– Courts have also found that exclusive patent licenses cannot be assumed or
assigned.
•
Copyright Licenses
– While few cases have addressed Section 365(c)(1) of the Bankruptcy Code and
its applicability to copyright licenses, these courts have found that pursuant to
federal copyright law, non-exclusive copyright licenses cannot be assumed and
assigned in bankruptcy without the consent of the licensor.
– Courts are split on whether exclusive copyright licenses can be assumed and
assigned in bankruptcy.
104
Hypothetical Test vs. Actual Test
• There is a conflict among the circuits as to
the applicability of Section 365(c)(1) when
a debtor licensee seeks to assume the
license and has no intention of assigning
the license to another party.
105
Hypothetical Test
• The Third, Fourth, Ninth and Eleventh
Circuit apply the “hypothetical test.”
• These circuits take a literal reading of
Section 365(c)(1).
• The Debtor’s intention to assign the
license is irrelevant.
106
The Harsh Result of the
Hypothetical Test
• RCI Technology Corp. v. Sunterra Corp., 361
F.3d 257(4th Cir. 2004) – The debtor entered
into a license agreement with RCI whereby RCI
granted the debtor a fully-paid irrevocable
license to use RCI’s software in exchange for a
$3.5 million license fee.
• Prior to the bankruptcy, the debtor paid the $3.5
million license fee and expended $38 million in
connection with modifying the licensed software.
• The debtor was not seeking to assign the
agreement and only sought to assume the
107
agreement.
The Harsh Result of the
Hypothetical Test (cont’d)
• RCI Technology Corp. v. Sunterra Corp., 361
F.3d 257(4th Cir. 2004)
• The actual licensing agreement authorized the
debtor licensee to assign the agreement.
• Applying the “hypothetical test”, the Fourth
Circuit found that the license agreement could
not be assumed notwithstanding the fact that the
license agreement permitted an assignment to a
purchaser of substantially all of the debtor’s
assets.
108
To Avoid the Result in Sunterra Corp.
• ** Pre-Bankruptcy Drafting – The license
agreement should explicitly provide for the
licensor’s consent to assignment as well
as consent to the Debtor’s assumption of
the licensing agreement in the event of a
bankruptcy filing.
109
The Actual Test
• The First and Fifth Circuits apply the “actual test”
in determining whether Section 365(c)(1)
prohibits a debtor-licensee from assuming a
license agreement.
• Under the “actual test”, the disjunctive “or” in
Section 365(c)(1) (“The Trustee may not assume
or assign . . . if excusable law excuses a party . .
. from accepting performance from another entity
. . .”) as the conjunctive “and”.
• Thus, a debtor is permitted to assume a license
agreement provided that the debtor has no
intention of assigning the contract.
110
To Avoid the Result in Pasteur
• ** Pre-Bankruptcy Drafting – In the
Pasteur case, the Court recognized that
the licensor could have inserted
restrictions in the cross-license which
impacted the Debtor’s continued rights
under the cross-license if there was a
change in stock ownership or corporate
control. Pasteur, supra at 494.
111
Ipso Facto Termination Clause
• Can the licensor terminate the license
pursuant to a provision in the agreement
which authorizes the licensor to terminate
the agreement upon the licensee’s filing
for bankruptcy – an ipso facto termination
clause?
112
Ipso Facto Termination Clause
(cont’d)
• Exception to the General Rule –
– Two Part Test Under Section 365(e)(2) of the Bankruptcy Code.
– The prohibition against enforcement of the ipso facto termination
clause does not apply if:
“(i) applicable law excuses a party, other than the debtor, to such
contract or lease from accepting performance or rendering
performance to the trustee or to an assignee under such contract
or lease, whether or not such contract or lease prohibits or
restricts assignment of rights; and (ii) such party does not
consent to such assumption or assignment . . .”
11 U.S.C. § 365(e)(2).
113
Unable to Assume License
• If the Debtor is unable to assume the license, is
the license deemed rejected?
• Courts have allowed intellectual property
licensing agreements to “ride through” the
bankruptcy case.
• The “ride through” doctrines “provides that
executory contracts that are neither affirmatively
assumed or rejected by the debtor under
Section 365, pass through the bankruptcy estate
unaffected.” In re Hernandez, 287 B.R. 795, 799
114
(Bankr. D. Az 2002).
Secured Creditor’s Foreclosure
Upon Debtor’s Intellectual Property
• When a secured creditor with a lien on all of the Debtor’s
assets seeks to foreclose on intellectual property, which
is the subject of a license agreement, Section 365(n)
protects the licensee’s interest. The licensee can retain
its interest in the intellectual property subject to the
payment of royalties which are remitted to the secured
creditor.
• This comports with Article 9 of the UCC. Section 9321(b) provides that “[a] license in the ordinary course of
business takes its rights under a nonexclusive license
free of a security interest in the general intangible
created by the licensor, even if the security interest is
perfected and the licensee knows of its existence.” UCC
115
9-321(b).
PRE- AND POST- BANKRUPTCY RIGHTS OF CREDITORS
Materials prepared by James N. Lawlor
Partner, Wollmuth Maher & Deutsch
One Gateway Center, Ninth Floor
Newark, NJ 07102
- and 500 Fifth Avenue
New York, NY 10110
Email: [email protected]
Phone: 973-733-9200
www.wmd-law.com
All Rights Reserved
116
Key Terms in Bankruptcy Proceedings
•
•
•
•
•
•
•
Chapter 11
Chapter 7
Chapter 13
Property of the Estate
Claims
Secured vs. Unsecured Claims
Prepetition vs. Postpetition Claims
117
Key Terms (cont’d)
•
•
•
•
•
•
Discharge
Automatic Stay
Avoidance Actions
Preferences
Fraudulent Transfers
Statements and Schedules
118
Key Parties In Interest
•
•
•
•
The Debtor-in-Possession
Chapter 11 Trustees
Chapter 7 Trustees
United States Trustee
119
Treatment of Prepetition Creditors
•
The Debtor-Creditor Relationship
•
Pre-Filing
•
•
Governed by contract and applicable non-bankruptcy law
Post -Filing
•
•
•
The Automatic Stay comes into effect, barring actions to
adjudicate or realize on debt
Unsecured creditors must usually file a claim and wait
until the conclusion of the proceeding to be paid, if at all
Secured Creditors retain rights of priority but are still
subject to the stay
120
Treatment of Creditors (cont’d)
•
Rights of Secured Creditors
•
Pre-Filing
•
•
Powerful rights, including right to foreclose, take
possession of collateral and sell it to satisfy debt
Post -Filing
•
•
•
•
The Stay bars enforcement actions and stops
foreclosures
Debtors often seek to use cash collateral to operate in
reorganization proceedings
Entitled to adequate protection for the collateral
Secured creditors often need to seek stay relief to protect
deteriorating assets, but are not assured that such relief
will be granted
121
Treatment of Creditors (cont’d)
•
Contractual and Lease Relationships
•
Pre-Filing
•
•
Right to damages and to cease performing when other
party breaches
Post -Filing
•
•
•
The Stay bars exercise of contractual rights against the
Debtors and trustees
Debtor is free to enforce its rights pending the conclusion
of a Chapter 11
Debtor can either assume or reject a lease or contract
122
Treatment of Creditors (cont’d)
•
Special Considerations as to Contracts
•
Non-Debtor Recourse in the Face of
Uncertainty
•
•
May seek to compel Debtor to make a
determination of whether to assume or reject a
lease or contract on fairness grounds
Agreements Terminated Prepetition
•
Bankruptcy does not revive such agreements.
123
Treatment of Creditors (cont’d)
•
Special Considerations (cont’d)
•
Non-Assumable Agreements
•
•
Certain types of agreements may not be
assumed by a debtor
License Agreements/Shopping Center
Leases
•
Special rules apply to licenses and shopping
center leases in bankruptcy.
124
Treatment of Creditors (cont’d)
•
Preventing Assignments of Contracts/Leases
•
Pre-Filing
•
•
Governed by contract and state law
Post -Filing
•
Anti-assignment clauses are generally not enforceable
125
Treatment of Creditors (cont’d)
•
Non-Competes/Restrictive Covenants
•
Pre-Filing
•
•
Enforceable as long as reasonable
Post -Filing
•
Bankruptcy will generally not eliminate the
restrictions
126
Treatment of Creditors (cont’d)
•
Right to Arbitrate Claims
•
Pre-Filing
•
•
Strong public policy for arbitration
Post -Filing
•
Bankruptcy courts follow the general rule that
parties that specify arbitration of disputes will
be required to arbitrate the amount and extent
of claims
127
Creditors Transacting With
Debtors/Trustees
•
•
•
Creditors Engaged in Postpetition
Transactions Are Protected
503(b) of the Code grants Priority
treatment for services or goods
provided to estate, as long as actual
necessary costs and expenses of
preserving the estate
Examples: wages, rents, repairs, taxes
128
Sometimes Forgotten Rights
•
Right of Recoupment and Setoff
•
Recoupment
•
•
Setoff
•
•
Enforceable
Can be lost through discharge and failure to
seek stay relief
Reclamation
•
Special rules apply that may elevate the claims of
reclaiming creditors
129
Enhanced Claims of
Debtors/Trustees
•
•
Preferences
Fraudulent Transfer Claims
130
Questions and
Answers
Thank you for coming!