A Dozen Things That A Business Lawyer Should Know About The Bankruptcy Abuse Prevention And Consumer Protection Act Of 2005 - Part I

Wednesday, February 1, 2006 - 00:00
Patrick A. Murphy

"One of the prime purposes of the bankruptcy law has beenÉto protect creditors from one another."
Mr. Justice Black in Young v. Higbee Co., 324 U.S. 204 (1945).

Based on a belief that individual debtors were abusing the fresh start provided by the Bankruptcy Code, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"),1 which was signed by President Bush on April 20, 2005. Although most lawmakers' pronouncements and press reports have described BAPCPA as consumer legislation,2 a substantial part of the new law deals directly or indirectly with business bankruptcy.

BAPCPA contains three key categories of business-related provisions:

  • Many amendments and new provisions ranging from trivial to substantial are located within Chapter 11 or elsewhere in the Bankruptcy Code, but have a significant impact on business bankruptcy cases.

  • Extensive changes directed to small business cases and individual cases sometimes spill over into larger corporate cases.3

  • Further revisions to Chapter 11 with the grandly stated objective of "Preventing Corporate Bankruptcy Abuse" resulted in half a dozen changes of minor importance.
  • BAPCPA favors certain creditors at the expense of the estate and, ultimately, of other creditors. The big winners are trade creditors, utilities, taxing agencies, vehicle finance companies, and real property lessors. The losers appear likely to include commercial secured lenders, general unsecured creditors, and debtors in retail businesses, which will find that disputes and litigation will increase and that their recoveries in Chapter 11 cases will decline.

    In reviewing BAPCPA, 12 topics stand out as particularly important to business lawyers.

    The Effective Date, The Interim Rules, And Life In Parallel Universes

    Most provisions of BAPCPA took effect for cases commenced on or after October 17, 2005, but there are many exceptions.

    Most of the provisions of BAPCPA apply to cases commenced on or after October 17, 2005, which is 180 days after the date of enactment (April 20, 2005). Some of the amendments took effect in cases commenced on or after the enactment date or at various other times, and a few provisions were made immediately applicable to cases that were already pending as of the enactment date. Unlike consumer cases, Chapter 11 business cases can be protracted. Thus, parallel universes will coexist in Chapter 11, with BAPCPA's amendments applying to some issues but not to others, for as many years as it takes for cases commenced prior to October 17, 2005, to work their way through the system. This will require caution in both research and statutory analysis. To be sure of applying the correct body of law, a business lawyer must determine not only whether a case was commenced before or after the effective date, but whether particular provisions apply to that case.

  • Lawyers must be careful to identify provisions that Congress placed in consumer amendments but which also apply to business cases. In some instances this is intentional; in others it appears wholly unintentional.

  • BAPCPA favors a "one size fits all" approach potentially inconsistent with the remainder of the Bankruptcy Code, which is designed to be balanced but flexible. As a result, some of the amendments may clash with familiar principles of underlying law.
  • BAPCPA suffers from both technical and drafting errors. Technical amendments are already being discussed, and transitional rules are in preparation.4 As to the conceptual problems - instances in which BAPCPA cannot be reconciled with the philosophical approach permeating the Bankruptcy Code and related case law - it will take time and cost money to bring the law back into balance.

    Real And Personal Property Leases

    Real property lessors have much greater leverage in Chapter 11 cases.

    Section 365 of the Bankruptcy Code deals with executory contracts and unexpired leases and the timeline for a debtor's decision to assume or reject such agreements. The stakes are especially high when it comes to commercial real estate leases and personal property leases; grappling with these concerns, Congress has revised the procedure under § 365(d) on several occasions before BAPCPA, most recently in the 1994 amendments to the Code.

    The two fundamental issues are payment of the rent provided for in the lease (which may involve immediate cash payments or the accrual of administrative claims) and the time within which the estate must assume or reject the lease. The estate's argument is that the lessor should not complain as long as the rent is being paid. The lessor counters that unless the lease has been assumed, the debtor can walk away at any time by electing to reject, while in the interim a qualified replacement lessee may have come and gone.

  • Prior to BAPCPA, a Chapter 11 debtor was given 60 days in which to assume or reject an unexpired lease of nonresidential real property, but the 60-day period was subject to extension for "cause shown." The procedural requirements for extensions were unclear, leading to disputes over the propriety of such requests, but they were often granted serially in cases where the rent was being paid and the debtor's operations appeared at least moderately stable.

  • In addition, for leases not yet assumed or rejected, pre-BAPCPA sections 365(d)(3) (applicable to non-residential real property) and 365(d)(10) (applicable to personal property) required the estate to timely perform the debtor's post-petition lease obligations beginning no later than 60 days after the commencement of the case, although that deadline could be extended for personal property leases.
  • BAPCPA substantially amends § 365(d) in a manner that shifts leverage to the lessor. Section 365(d)(4) now provides for a 120-day period in which the estate must assume or reject an unexpired real property lease, but the estate may obtain only one 90-day extension for cause shown. Any further extensions require the express written consent of the lessor. If the lease is not assumed within the required period, it will be deemed rejected, terminating the debtor's rights under the lease. In what might be meant as a trade-off, BAPCPA also provides that if a lease is assumed but later rejected, the lessor's claim is limited to two years' worth of rent and other monetary obligations (excluding penalties and those arising from a failure to operate), with priority administrative expense status under § 503(b)(7). Any claim for other sums due under such a lease is treated as "a claim under § 502(b)(6)." These amendments raise various questions, including:

  • What is meant by "a claim under § 502(b)(6)"? Section 502(b)(6) is a limitation on the amount of an otherwise allowable claim.

  • Does the lessor have a duty to mitigate damages, or is the right to a two-year claim absolute? The result is not made any clearer by BAPCPA's reference to sums the lessor receives from entities other than the debtor.
  • Absent lessor consent, a debtor now has a maximum of 210 days to assume a commercial lease. This will require careful advance planning, especially for retailers, and can create significant problems if the Chapter 11 plan confirmation process is delayed.5

    Claims Of Sellers Of Goods

    Sellers of goods enjoy substantially improved rights, which are likely to cause a cash drain in retail cases.

    Section 546 of the Bankruptcy Code is captioned "Limitations on Avoiding Powers." Subsection (c) originally protected sellers of goods who, but for the commencement of a bankruptcy case, could have retrieved the goods from an insolvent debtor under either a statutory or common-law right of reclamation.6 BAPCPA pushes § 546(c) beyond protecting the rights of creditors as against a bankruptcy estate. The amendment creates an independent federal statutory right to reclaim goods sold in the ordinary course of business, and then insulates that right from attack under § 544(a) (the estate's "hypothetical creditor" avoidance powers), § 545 (avoidance of statutory liens), § 547 (avoidance of preferential transfers), and § 549 (avoidance of postpetition transfers).

    The new reclamation right is apparently derived from the Bankruptcy Code rather than nonbankruptcy law. The seller is required to demand reclamation in writing within 45 days of the debtor's receipt of goods. If the 45-day period has not expired before commencement of a bankruptcy case, it is automatically extended by 20 days.

    1 Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat.23 (2005).

    2 BAPCA significantly revises the law applicable to individual bankruptcy cases. The changes include credit counseling requirements, a means test to determine when a Chapter 7 filing will be presumed to be abusive, reductions in the "fresh start" benefits available to debtors in cases under both Chapter 7 and Chapter 13, family law provisions that focus on the payment of domestic support obligations, enhanced exemption privileges for retirement and educational savings accounts, and provisions that render nondischargeable certain debts incurred through securities fraud or breaches of fiduciary duties.

    3 In addition, some policy changes in other parts of the Bankruptcy Code required conforming amendments in Chapter 11. Examples are changes in the law relating to domestic support obligations and the treatment of post-petition earnings of an individual in a Chapter 11 case.

    4 The Judicial Conference Advisory Committee on Rules of Bankruptcy Procedure has prepared Interim Rules Amendments and Rules Additions which, if adopted on a local basis, will apply to bankruptcy cases from October 17, 2005, until final rules and forms are promulgated and have become effective under the Rules Enabling Act, upon approval by Congress and adoption by the Supreme Court.

    5 BAPCA also amends §365 to address for the first time the treatment of non-monetary defaults under nonresidential real property leases. Unfortunately, the enactment does not address such defaults in personal property leases and other executory contracts.

    6 See UCC§2-702.

    David A. Honig and Patrick A. Murphy are corporate partners in Winston & Strawn's San Francisco office. Mr. Honig concentrates his practice in bankruptcy matters and related litigation in the telecommunications and technology industries. He can be reached at (415) 591-1423. Mr. Murphy concentrates his practice in corporate reorganizations and insolvency law. He can be reached at (415) 591-1500.

    Please email the authors at dhonig@winston.com or pmurphy@winston.com with questions about this article.

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