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The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was enacted on April 20, although the effective date for most provisions does not occur until Oct. 17. Much has been written and said about the act’s controversial changes to consumer bankruptcy law, but little has been noted about its many changes to business bankruptcy law. This article discusses the most important of those changes. Virtually every business that sells on credit has been sued by a trustee, debtor-in-possession or other representative of a customer’s bankruptcy estate for avoidance and recovery of a preference. A “preference” is a payment or other transfer of property (including a lien on property) by an insolvent debtor that is to or for the benefit of a creditor, for or on account of an antecedent debt and made during the 90 days (one year if the creditor is an insider) immediately preceding the debtor’s bankruptcy filing. Preferences can be avoided and recovered unless the transferee proves that one or more statutory defenses apply. The new bankruptcy act enhances preference defenses in several ways. First, it makes the “ordinary course of business” defense easier to prove. Under existing law, the defense requires proof that the preference was made both in the ordinary course of business or financial affairs of the debtor and transferee and according to ordinary business terms. Under the new act, the transferee need prove only one or the other. Second, the act adds a new defense available only in bankruptcy cases that do not involve primarily consumer debts. In such cases, a transfer will not be an avoidable preference if “the aggregate value of all property that constitutes or is affected by such transfer is less than $5,000.” Third, the act provides that if the trustee avoids a transfer made between 90 days and one year prior to the petition date to a noninsider creditor for the benefit of an insider creditor, the transfer can only be avoided as to the insider creditor. (The law already provides that such preferences can only be recovered from the insider creditor.) Fourth, the law currently provides that a purchase money security interest is not avoidable as a preference if it is perfected within 20 days after the debtor receives the purchased property. The new act expands the time to perfect to 30 days. Finally, the act requires that a lawsuit to recover preferences totaling less than $10,000 be brought in the defendant’s home district, rather than in the bankruptcy court where the debtor’s case is pending. The act materially benefits vendors that sell goods on open credit. The period for which goods may be reclaimed is increased from 10 days to 45 days. The vendor must demand reclamation of goods in writing no later than 45 days after the debtor’s receipt of the goods or no later than 20 days after the date of the commencement of the bankruptcy case if the 45-day period expires after commencement of the bankruptcy case. Another amendment provides that a vendor’s reclamation right “is subject to” the prior right of a holder of a security interest in the subject goods and proceeds thereof. The wording of this amendment seems to overrule the minority view that no reclamation claim exists for goods subject to a lien even if there is value in the goods over and above the lien. In addition to expanding and clarifying reclamation rights, the act gives vendors an administrative-expense priority claim for the value of any goods sold to and received by a debtor in the ordinary course of the debtor’s business within 20 days before the start of the debtor’s bankruptcy case. To qualify for this claim, no proof is required that the goods are still in the debtor’s inventory or that they are not subject to the rights of a secured creditor. These changes affecting vendors raise a number of questions: Will a vendor be able to reclaim goods for the full 45-day period and also be allowed an administrative-expense priority claim for the overlapping 20-day period, or must the vendor make an election of remedies? If a vendor makes demand and then prosecutes a reclamation claim for the full 45-day period, may the claim be settled by court order approving the debtor’s retention of the goods in exchange for granting the vendor an administrative-expense priority claim for the value of the goods? Will settling on these terms be a way to expand beyond the 20-day administrative-expense priority claim to which all vendors will be entitled without making a reclamation demand? Because the act’s only remedy for the period from 20 to 45 days prior to commencement of the bankruptcy case is physical reclamation of goods, will vendors have to be proactive early in the case, seeking relief from the automatic stay so that goods can be reclaimed; discovery of the debtor’s business records concerning receipt of goods and any creditors secured by the debtor’s inventory; and/or an injunction against the debtor’s selling or otherwise disposing of the goods pending a resolution of the reclamation claim? In addition to vendors, commercial landlords are also big winners under the act. Under current law, the decision to assume or reject a nonresidential real property lease must be made within 60 days of the petition date unless extended by court order. Many bankruptcy courts have adopted the practice of allowing Chapter 11 debtors extensions up to the date of plan confirmation — often a year or more after the petition date. The new act puts an end to that practice, enlarging the initial decision period from 60 to 120 days, authorizing the court to grant a single 90-day extension for cause upon motion made during the initial 120-day period and permitting further extension only with the landlord’s prior written consent. Under existing bankruptcy law, a debtor cannot assume an unexpired lease without curing defaults or providing adequate assurance that defaults will be cured. The courts have split on whether the cure requirement applies to nonmonetary as well as monetary defaults. The act clarifies the issue. First, as to all real property leases, debtors must cure all nonmonetary defaults that are capable of cure by performing nonmonetary acts at, and after, assumption. Second, as to nonresidential real property leases only, debtors must cure all nonmonetary defaults arising from the failure to operate in accordance with the leases by performing nonmonetary acts at, and after, assumption. If such default is impossible of cure, it appears that the lease may not be assumed over the other party’s objection. In addition, any pecuniary losses suffered by a landlord as a result of a debtor’s failure to operate in accordance with a nonresidential real property lease must be compensated as a condition of assumption. The act provides generally that a class of commercial landlords is not impaired and therefore not entitled to vote on a Chapter 11 plan if the class’s claims or interests all arise from the debtor’s failure to perform a nonmonetary obligation and the plan compensates the class members (other than the debtor or an insider) for any actual pecuniary loss incurred as a result of such failure to perform. However, if the debtor’s failure to perform a nonmonetary obligation concerns a nonresidential real property lease, the class of commercial landlords will be impaired and entitled to vote. The act strengthens the remedies of a commercial landlord whose lease the debtor first assumes and later rejects in three ways. First, it grants the landlord an administrative-expense priority claim for all monetary obligations due under the lease (excluding only obligations arising from or relating to failure to operate or a penalty provision) for two years following the later of the rejection date or the date the premises are turned over. Second, it restricts offsets or reductions to this administrative priority claim to sums actually received or to be received by the landlord from an entity other than the debtor. Finally, it grants the landlord an unsecured nonpriority claim for any remaining sums due under the rejected lease (i.e., beyond sums due during the two-year period). SMALL BUSINESS DEBTORS Special Chapter 11 rules and procedures apply to a debtor that qualifies, and elects to be treated, as a “small business debtor.” As currently defined, the term means a person engaged in commercial or business activities (other than real estate) whose aggregate noncontingent, liquidated debts, both secured and unsecured, do not exceed $2 million on the petition date. The act substantially amends this definition by requiring that the $2 million debt limit not be exceeded on either the petition date or the date the order for relief is entered in an involuntary case; by excluding from the $2 million limit any debt owed to affiliates or insiders; and by excluding cases where a creditors’ committee has been appointed unless the court has determined that the committee is not sufficiently active and representative to provide effective oversight of the debtor, and by including any affiliate that is also a debtor (except for any member of an affiliated group of debtors with debt that exceeds the $2 million limit). In another change to the law governing small business Chapter 11 cases, the $2 million debt limit is subject to adjustment in future years. Additionally, debtors are required to file periodic financial statements and reports containing information on profitability, cash flow projections, actual receipts and disbursements, compliance with tax and other filing and payment obligations, and other matters. Also, the Judicial Conference is required to prescribe standard-form financial statements and reports for debtors as well as standard-form disclosure statements and plans designed to balance the need for information against the needs for economy and simplicity. Further, debtors are charged with specific duties to file with their petitions (or within seven days after an order for relief is entered in an involuntary case) their most recent balance sheets, operating statements, cash flow statements and federal income tax returns; to have senior management attend meetings scheduled by the court and the U.S. trustee; to file timely schedules, statements of financial affairs and monthly operating reports; to maintain insurance customary and appropriate to the industry; to file tax returns and pay taxes timely; and to allow inspection of books and records by the U.S. trustee. In other changes, the initial exclusivity period for a small business debtor to file a plan is extended from 100 days to 180 days; the period during which any party must file a plan and disclosure statement is extended from 160 days to 300 days; and if a plan filed in a small business case satisfies confirmation requirements, the court must confirm it within 45 days after the filing. Also, in a material departure from current practice, the U.S. trustee is required to become actively involved in investigating, monitoring and assisting the small business debtor and to seek conversion or dismissal of the case if circumstances warrant. Finally, the automatic stay does not protect a small business debtor guilty of serial Chapter 11 filings. It remains to be seen whether the act’s changes to small business reorganization law will make the election by qualifying debtors more or less attractive. Under existing bankruptcy law, the term “single asset real estate” means property securing no more than $4 million in noncontingent, liquidated debt. The new law eliminates any dollar cap on secured debt. To keep the automatic stay in place, single-asset real estate debtors are currently required within 90 days after the order for relief is entered (or such later date as the court may order for cause) either to file a Chapter 11 plan that has a reasonable possibility of being confirmed within a reasonable time or to commence monthly payments to secured creditors. The act codifies the practice of many courts to allow single-asset real estate debtors to use the rents and income generated from their properties to fund the required monthly payments to secured creditors. The act also amends the time period for filing a plan or starting payments by making it the later of 90 days after the order for relief is entered or 30 days after the court determines that it is a single-asset real estate case. Finally, the act provides that the monthly payments must be made in an amount equal to interest at the nondefault contract rate (as opposed to the current fair market rate under existing law) on the creditor’s interest in the property. Although too numerous to discuss, there are a host of other changes to business bankruptcy law found in the act’s 512 pages, including changes affecting fraudulent transfers; bankruptcy cases by “health care business” debtors; Chapter 11 cases by individual debtors; dismissal, conversion and appointing a trustee in Chapter 11 cases; bankruptcy notices to creditors; information rights of creditors; warehouseman’s liens; obligations to insiders and consultants; bankruptcy committees; involuntary bankruptcy cases; prepackaged plans; the debtor’s exclusive periods to file and gain acceptances of a Chapter 11 plan; the definitions of “disinterested person” and “transfer”; utilities; debtors that are nonprofit charitable corporations or trusts; appeal rights; and employee wage and benefit priorities. William B. Sullivan is a senior partner at Womble Carlyle Sandridge & Rice, in its Winston-Salem, N.C., office, and the head of the firm’s bankruptcy group. He can be reached at [email protected] Julie B. Pape, a bankruptcy associate at the firm, assisted with the preparation of the article.

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