The Bankruptcy Abuse Prevention and Consumer Protection Act 2005 will have a profound impact on Chapter 11 cases, including the trading and valuation of bank debt and trade claims. Even though the act was primarily intended for consumers, there are important consequences for corporate bankruptcies, explained David Feldman, a partner at Kramer Levin Naftalis & Frankel LLP, speaking last week at the Loan Syndications and Trading Association's inaugural Standard Documents & Market Practices For The Syndicated & Loan Trading Market, in New York.
The bill was approved in the House last week and is expected to be signed by the president within the next few weeks. The 2005 amendments will only apply to cases that begin 180 days after the president signs the bill, said Thomas Moers Mayer, a partner at Kramer Levin. But this could lead some companies that enjoy some benefits under the current code to look to file before then. Not only will the changes affect bank debt trading, they will promote the role of crisis management firms and make life tougher for management.
Mayer explained that in one key change, the bankruptcy code has been amended to give sellers of goods an automatic administrative expense priority for any amounts they are owed for goods shipped in the past 20 days before the commencement of the case. Previously, trade creditors could only seek a reclamation priority for goods shipped in the past 10 days and they often lost. "So instead of a questionable reclamation claim for goods shipped in the last 10 days, they will have a guaranteed administrative expense claim for goods shipped in the last 20 days. Since Chapter 11 plans can pay pre-bankruptcy secured bank debt over time but must provide for immediate cash payment of all allowed administrative claims, the new statute will in some instances give trade creditors effective priority over secured banks," Mayer stated.
"The banks could come under pressure because their repayment can be stretched and ultimately, it may make it harder for companies to emerge from bankruptcy because they will not have the cash to pay the inflated expenses and could also push secured bank creditors to push for liquidation to avoid paying trade claims expenses," Mayer added. In certain bankruptcies this could increase the value for the bank debt holders. For example, first-lien debtors can liquidate faster, but the residual value of the properties could be worse for second-lien lenders.
There are two key areas that will also affect management, encouraging some companies to file before the Act kicks in, since "some bankruptcies will be a suicide pact for the management," Mayer suggested. There will be major changes to the Key Employee Retention Plans (KERPS). The amendments will place limits on retention bonuses and severance to managerial positions. The second requirement is that the person has to have a better offer in hand. "KERPS have been abused in the past and there is something unseemly when everybody is getting hit--bondholders, securities holders, employees--and the managers are demanding they be paid a fortune and saying if they don't the world will come to an end. This is a reaction to that. But you do need management and it will be harder to retain people," Mayer stated.
Additionally, the courts will also be encouraged to appoint a trustee if there are reasonable grounds to suspect that management was engaged in reporting misstatements leaving the unambiguous winners in this amendment the restructuring crisis managers.
"Chapter 11 has been increasingly adopted abroad in the past twenty years, but these changes move the U.S. to the older European model where you put a neutral party in place en route to liquidation," Mayer argued. However, on both issues "One should not underestimate the power of inertia. People will work hard to soften and circumvent the statute and I don't want to bet against the power of inertia," he concluded.
