BANKRUPTCY AND THE AUTO INDUSTRY: AN ANALYSIS OF (1) THE EFFECTS OF THE RECENT CHANGES TO THE BANKRUPTCY CODE ON AUTO INDUSTRY BANKRUPTCIES; (2) COURT OPINIONS IN AUTO INDUSTRY BANKRUPTCIES; AND (3) SPLITS AMONG THE CIRCUITS WHERE AUTO INDUSTRY BANK RUPTCIES ARE MOST OFTEN FILED Prepared for the Turnaround Management Association Pittsburgh Chapter Presented February 21, 2006 By: David A. Murdoch Jamie A. Bishop Jamie L. Burchianti Lopez Kirkpatrick & Lockhart Nicholson Graham LLP Henry W. Oliver Building 535 Smithfield Street Pittsburgh, PA 15222 (412) 355 - 6500 PI - 1519540 v1
I. Changes to the Bankruptcy Code That Affect Business Bankruptcies A. Time Limitations on a Debtor s Ability to Submit a Plan for Reorganization 1. Old Law: a. Prev iously, debtors had an exclusive right to file a plan of reorganization during the first 120 days after the commencement of the case. 11 U.S.C. § 1121(b) (2000). b. In practice, courts have been very lenient in granting numerous extensi ons to debtors. 2. Changes in the Code: a. Section 1121 of the Bankruptcy Code has been amended to reduce the lengthy extensions that have been granted by bankruptcy courts. The new law states that the 120 - day period may not be extended beyond 18 months after the petition date. 11 U.S.C. § 1121(d)(2)(A). b. If the debtor s exclusive period to file a plan of reorganization expires, the creditors committee or any other party- in - interest can file its own plan of reorganiz ation or liquidation for the debtor. c. Creditors have gained leverage because of this change. Creditors now know that if a debtor cannot submit a plausible plan by the deadline, a creditor can submit its own plan of reorganization. The absolute limitation on a debtor s ability to seek extensions to file its plan allows a creditors committee to refuse to negotiate with the debtor as the deadline approaches. Once the deadline passes, the committee can submit its own reorga nization plan for the debtor. B. Capping Executive Compensation 1. Old Law: a. The Bankruptcy Code did not limit executive compensation. b. When larger corporations filed Chapter 11 reorganization cases, senior executives often were enrolle d in Key Employee Retention Programs ( KERPS ) or given luxurious monetary incentives to remain with the company. c. In many cases, only senior executives received these payments, usually in the form of a bonus. The bonuses frequently were large and diluted the cash available for distribution to creditors. - 2 -
2. Changes in the Code: a. Retention: i. The amended Bankruptcy Code states that retention programs for the purpose of convincing an insider to remain with the debtor s company are not allowed unless the payment is both: (a) essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation; and (b) the services provided by the person are essential to the survival of the business. 11 U.S.C. § 503(c). ii. Even if both requirements are satisfied, the amount that an individual can receive under a retention program is capped. An individual s compensation cannot be 10 times the average amount given to non- management employees for any purpose during the calendar year in which the obligation is incurred. 11 U.S.C. § 503(c)(1)(C). b. Severance: i. Severance payments cannot be made to insiders unless the payments are part of a larger program generally available to all full - time employees. 11 U.S.C. § 503(c)(2). ii. The amount of compensation that an insider can receive in a severance package is limited. An insider s severance package may not be greater than 10 times the average severance pay given to non -management employees in that year. C. Changes Relating to Preference Actions 1. Ordinary Course of Busin ess Defense a. Old Law: i. Previously, to qualify for the ordinary course of business exception to a preference action, a creditor had to prove three elements: - 3 -
(a) the transfer was in payment of a debt incurred by the debto r in the ordinary course of business or financial affairs of the debtor and creditor; (b) the transfer was made in the ordinary course of business between the debtor and creditor; and (c) the transfer was made in accordance with o rdinary business terms. 11 U.S.C. § 547 (c)(2) (2000). ii. Courts struggled in determining what the difference was between the ordinary course of business between the debtor and creditor element and the ordinary business terms element. As a result, courts read this statutory provision as requiring creditors to prove that transactions were subjectively and objectively ordinary. (a) The Subjective Test: (1) The creditor has to prove that the payment was the typical type of payment made in the parties established course of dealings. (2) The creditor must show that transactions both before and during the 90 - day period were consistent. (3) Factors t o determine if the transfer was ordinary are: i) the length of time the parties were engaged in the transaction in issue; ii) whether the amount or form of tender differed from past practices; iii) whether the debtor or creditor engaged in any unusual collection or payment activities; and iv) the circumstances under which the payment was made. - 4 -
Payne v. Clarendon Nat l Ins. Co. (In re Sunset Sales, Inc.), 220 B.R. 1005 (B.A.P. 10th Cir. 1998). (b) The Objective Test: (1) A creditor also was forced to show that the payment was made according to ordinary business terms used in an established industry standard. (2) To prove that the objective prong of the test was satisfied, creditors usually had to hire expert witnesses to testify at trial. Therefore, even if a creditor could prove that a payment was made in the ordinary course of business, it typically had to spend large amounts of money on expert witnesses and litigation. b. Changes in the Code: i. Elements of the New Defense: (a) The transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and creditor; and either (1) the transfer was made in the ordinary course of business or financial affairs of the debtor and the creditor; or (2) the transfer was made according to ordinary business terms. 11 U.S.C. § 547 (c)(2). ii. Realizing the tremendous expense and difficulty for a creditor to prove that a transaction was made in ordinary business term s used in a particular business and locality, Congress altered the ordinary course of business defense in a way that eliminates the need for objective data in most cases. - 5 -
2. Small Transfer Exception: a. Creditors who received payments during the 90 - day period prior to the filing of the debtor s petition are no longer required to return the payments if the amount received is less than $5,000. b. The small transfer exception is an affirmative defense that must be raised b y the creditor. 11 U.S.C. § 547(c)(9). 3. Venue Amendments a. If a preference action against a business creditor who is not an insider is for less than $10,000, the preference action must be brought in the creditor s home district, regardless of where the bankruptcy petition was filed. 28 U.S.C. § 1409(b). b. Creditors who are forced to defend preference actions for claims less than $10,000 no longer have to hire counsel in the jurisdiction where the case was originally filed. D. Reclamation Demands 1. Old Law a. Under old law, it was clear that § 546(c) attempted to protect a seller s rights to reclamation under section 2- 207 of the Uniform Commercial Code. b. The seller could only reclaim goods if the seller de manded reclamation of such goods in writing before 10 days after receipt of such goods by the debtor or if the 10 days expired after commencement of the case, before 20 days after receipt of such goods by the debtor. c. The court could deny reclamation to a seller that made a demand if the court granted the claim administrative priority or secured the claim by a lien. 2. Changes in the Code a. Because of the lengthening of the reclamation period under the changes to the Bankruptcy Code a nd the elimination of language regarding statutory and common law rights in § 546(c), it appears that the statute creates a federal right of reclamation in bankruptcy cases. b. Seller may only reclaim goods if the seller demands reclamation of such goods in writing no later than 45 days after the date the - 6 -
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