The Examiners: Blame Cheap Money, Bankruptcy Laws and Expense of Cha...

When a company files for Chapter 11 protection a second, third or even fourth time, who’s to blame?

Before a bankruptcy court can confirm a Chapter 11 plan of reorganization, it must find that confirmation of the plan isn’t likely to be followed by the need for further financial reorganization. This requirement is often referred to as the feasibility test. Despite the feasibility requirement, repeat Chapter 11 filings—so-called Chapter 22 and even Chapter 33 bankruptcy cases—are increasingly common.

Three factors seem to pervade the recent repeat filings, encouraging companies to speed through a balance-sheet restructuring or sale process without truly addressing operational problems: cheap money, recent Bankruptcy Code amendments and the rising cost of Chapter 11.

Cheap money. The increased availability of liquidity through extended existing credit facilities or new funding often encourages debtors to exit Chapter 11 with debt levels too high to sustain post-bankruptcy. As a result, they are back in through the revolving door of the bankruptcy court, often for an expedited sale process, in a relatively short time.

BAPCPA’s leverage shift. A number of provisions in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, or BAPCPA, shifted control of Chapter 11 proceedings away from debtors to other constituents. BAPCPA shortened the time period within which a debtor has the exclusive right to file a plan of reorganization and exit Chapter 11 before a hostile competing reorganization plan may be filed. This limits the time a debtor has in Chapter 11 to fix operational issues or negotiate with creditors. Once that deadline passes, any creditor or equity holder may file a plan—potentially stripping the debtor of control over its case (or at a minimum, setting the stage for an expensive confirmation fight). As a result, a debtor may propose a plan prematurely so that it can confirm its own plan within the exclusivity period.

BAPCPA also limits the time period a debtor has to assume or reject its real-estate leases, permitting just four months for analysis and renegotiation of leases (with a possible three-month extension), after which no further extensions are available without landlord consent. For a debtor with a significant number of leased properties, such as a retail chain, this can be a daunting task.

BAPCPA broadened creditor safe harbors, effectively preventing the unwinding of certain financial transactions to prevent the destabilization of the financial markets as a result of uncertain treatment in bankruptcy. BAPCPA also extended the look-back period for priority wage claims and created a new administrative expense for trade creditors who sold goods to the debtor within 20 days of filing. These protections translate to more claims against the debtor and less cash for the debtor’s estate.

The costs of Chapter 11. Beyond the incremental burdens imposed on a debtor by BAPCPA, the administrative costs associated with prosecuting a Chapter 11 have risen dramatically over the past decade. As a result, debtors frequently enter Chapter 11 with an eye to a quick exit, whether through a fast sale process or a restructuring plan pre-negotiated with certain key constituents, often without focusing on effectuating a true operational restructuring. A reorganized Chapter 11 debtor that inherits prior operational problems—especially when it already has too much debt on its post-exit balance sheet—has to fix its operational problems somewhere.

As a result of one or a combination of these factors, companies that file for Chapter 11 frequently make a return trip to bankruptcy court.

Sharon Levine is vice chair of Lowenstein Sandler LLP’s national bankruptcy, financial reorganization and creditors’ rights practice. Follow her on Twitter at @LevineSharon.