Businesses Need Certainty; Distressed Businesses Need It Even More

The general counsel of a financially distressed company calls you.  She of course clearly states that her company does not need to file a chapter 11 case, but she is curious to understand how a chapter 11 case might work for her company.  Specifically, she wants to know: Can the company continue to use intellectual property it licenses and has integrated into its business operations?  Will some or all of the company’s existing shareholders be able to retain their ownership if they contribute to the company’s reorganization?  If the company decides to pursue a sale, can the company sell its assets free and clear of all claims?  Will she and the company’s other executives be released from any alleged liability if the company confirms a plan of reorganization?  What if the company reorganizes through a going concern sale instead?

All very astute questions, to which you will likely have to answer, “it depends.”  It depends primarily on where the company files its chapter 11 case.  These and other key issues in chapter 11 are subject to splits in the case law that create uncertainty and increase costs.  The splits require companies (and their creditors) to perform extensive jurisdictional analyses of issues likely to be important in any chapter 11 case.  Not surprisingly, one jurisdiction may be favorable on one issue, with another jurisdiction more favorable (or silent) on a different, equally critical issue. 

This uncertainty also creates ambiguity (or some might say opportunity) in chapter 11 cases.  If the jurisdiction in which a case is filed has not taken a position on a disputed issue—or if there is a split among the lower courts—gamesmanship and litigation may follow.  For example, in the plan context alone, consider courts’ various approaches to the classification rules, gifting and absolute priority deviations, third-party releases and exculpation, and vote designation.  No wonder parties are pursuing quick sales and structured dismissal orders: all of the confirmed plan benefits without the baggage, that is if your jurisdiction recognizes structured dismissals.

The ABI Commission studied splits in the case law under, and ambiguity in the interpretation of, the current Code.  It deliberated at great length concerning the various approaches to each issue and, whenever possible, developed a consensus position to resolve the split or ambiguity.  The list below sets forth just a few of the recommendations that resulted from these particular discussions.  These discrete aspects of the ABI Commission Report hold potentially significant value for chapter 11 and would go a long way towards unifying our uniform bankruptcy laws (and even potentially mitigating some of the venue choice disputes under existing law).

Proposed Recommendations to Resolve Case Law Splits:

• The standard of review applicable to the appointment of a chapter 11 trustee under section 1104;
• The permissibility of cross-collateralization and roll-up provisions in postpetition financing facilities;
• The proper use of the doctrine of necessity in chapter 11 cases;
• The ability of drop shipment transactions to qualify for administrative claim treatment under section 503(b)(9);
• The interplay between the priority afforded to wage claims under section 507(a)(4) and the priority afforded to employee benefit plan claims under section 507(a)(5);
• The ability of a debtor to apply section 1114 to terminate retiree benefit plans that the debtor has the right to unilaterally terminate outside the bankruptcy context;
• The definition of “executory contract” for purposes of section 365;
• The effect of rejecting an executory contract or unexpired lease under section 365;
• The ability of a debtor to assume intellectual property licenses under section 365(c) (i.e., the hypothetical test versus the actual test) and the treatment of trademark licenses generally;
• The proper calculation of a landlord’s claim against the estate (i.e., the accrual approach versus the billing date approach);
• The application of the safe harbor in section 546(e) to bar fraudulent transfer actions brought under applicable nonbankruptcy law (i.e., state laws including the Uniform Fraudulent Transfer Act or similar statutes as adopted in each state);
• The treatment of ordinary supply contracts as qualified financial contracts subject to the protection of the Bankruptcy Code’s safe harbor provisions;
• The meaning of “for the benefit of the estate” under section 550;
• The fiduciary duties of a debtor (as opposed to a debtor in possession) proposing a chapter 11 plan;
• The fiduciary duties of professionals paid from the estate; and
• The permissibility of gifting and nonconsensual third party releases in the context of a chapter 11 plan.

*Note: The views expressed in this post are those of the author and are intended to spark a meaningful dialogue about chapter 11 reform. They are not attributable to the American Bankruptcy Institute or the ABI Commission to Study the Reform of Chapter 11.

 Uncertainty image from Shutterstock.