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For
the seasoned bankruptcy or business lawyer, learning
another new bankruptcy code may be frightening.1 For
others, it presents an opportunity to plug into a
practice area from the ground up. Over the next few
months and years after the "Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005"2
becomes fully implemented on October 17, 2005,3 the
bankruptcy bar and business community will be challenged
to rediscover the art of interpreting the words left
by Congress that control the adjustment of debts and
the debtor-creditor relationship. A few of the new
provisions that may widely impact the business community
are the focus here—secured claims, preferential
transfers, contracts/leases and fraudulent conveyances.
Enough of the introduction, let's "talk law."4
I. Secured Claims
(i) Valuation
An examination of the
rights of a secured creditor necessarily requires
a review of 11 U.S.C. §506 (a) and (b). Unchanged
§506 (a), provides that a claim secured by a
lien on property of the debtor is a secured claim
to the extent of the value of the creditor's interest
in the debtor's interest in such property. Section
506 (b) has been amended to answer the question raised
by subsection (a) in the context of an individual
Chapter 7 or 13 case, that is, how to value the debtor's
interest in the property that is subject to the lien.
The amendment to subsection (b) provides that the
value is the replacement value of the property as
of the date of the petition, without deduction for
costs of marketing or sale. If the property is acquired
for personal, family or household purposes, replacement
value is the price a retail merchant would charge
for similar property at the relevant time.5
(ii) Secured Claims
in Chapter 13
A major change in the
Code relates to the treatment of secured claims in
Chapter 13 cases.6 As amended, the Code provides that
the retail value established in §506 is irrelevant
in a Chapter 13 case where a secured creditor's claim
is based on a purchase money loan incurred within
one year of the bankruptcy filing or within 910 days
of the bankruptcy filing if the collateral for the
purchase money loan is a personal use motor vehicle.
In those situations there can no longer be a cramdown!7
Under the amendments, the claim in those situations
must be paid in full, plus interest. All other secured
claims can be paid the "cramdown" value
established by §506(b).
Chapter 13 has also
been amended to provide that not only must a debtor
begin making payments to the trustee within 30 days
of the filing of the Chapter 13 plan, but a debtor
is also required to begin making adequate protection
payments within the same 30-day period directly to
a lessor of personal property and to a purchase money
creditor holding an allowed claim, secured by personal
property.8 The payments to the Chapter 13 trustee
are to be reduced by the amount of adequate protection
payments.
(iii) Secured Claims
in Chapter 7
In a Chapter 7 case,
a debtor's right to avoid the redemption or reaffirmation
of a secured claim, by maintaining the regular contractual
payments has been eliminated.9 A Chapter 7 debtor
must now choose to either redeem or reaffirm and in
the event of redemption, the valuation determined
pursuant to §506(b) must be paid in full at the
time of redemption. As discussed above, the redemption
value is the replacement value of the property as
of the petition date which is determined on the basis
of what a retail merchant would charge for similar
property.
(iv) Secured Claims
in Chapter 11
The significant changes
that have been made to the rights of secured creditors
in the context of Chapter 7 and 13 cases have generally
not been carried over to Chapter 11. Here the rights
of secured creditors remain substantially unchanged.
II. Preferences
A preference is a transfer
of property of the debtor, to or for the benefit of
a creditor, for or on account of an antecedent debt
owed by debtor, made when the debtor was insolvent,
made within 90 days of the bankruptcy filing, and
that enables the creditor to receive more than the
creditor would have received in a Chapter 7 proceeding
if the transfer had not been made.10 There have been
no changes to these basic elements of a preference.
A creditor's ordinary
course of business defense to repayment of an alleged
preference has been made much easier to prove by eliminating
the need to prove both (a) that the payment
was made in the ordinary course of business or financial
affairs of the debtor and transferee, and (b) that
the payment was made according to ordinary business
terms.11 The amendment, replaced "and" with
"or," resulting in the creditor proving
only one of the two alternative elements. This significant
change will make the ordinary course of business defense
more formidable for the benefit of the creditor.
Domestic support obligations
have traditionally been treated as any other transfer
subject to avoidance as a preference. Under the 2005
Amendments, pre-petition payments by a debtor of "domestic
support obligations"12 are specifically excepted
from avoidance as a preference.13
Some smaller transfers
may not be avoided as a preference: "if, in a
case filed by a debtor whose debts are not primarily
consumer debts, the aggregate value of all property
that constitutes or is affected by such transfer is
less than $5,000.00."14 It is unclear whether
this amendment seeks to exclude each preferential
transfer that is in an amount less than $5,000.00
or whether the $5,000.00 limitation is applied to
the sum of all transfers alleged to be preferential.
What does appear clear is that Congress seeks to limit
recovery of "nominal" transfers.
The grace period within
which a transfer must be perfected has been extended
from 10 days to 30 days.15 State law relation back
principles continue to apply.
To the extent an alleged preferential payment was
made pursuant to an alternative payment schedule created
by an approved "non profit budgeting and credit
counseling agency," the payment may not be avoided
as a preference.16
Lastly, a new provision
has been added to eliminate any remaining preference
exposure arising under the Deprizio line of cases,
and provides that only the insider may have preference
liability for transfers made between 90 days and one
year prior to the bankruptcy filing.17
III. Executory Contracts and Unexpired Leases
In all bankruptcy cases,
unexpired leases and executory contracts must be assumed
or rejected. Upon rejection, the lease is considered
breached as of the day before the bankruptcy filing,
and the lessor is entitled to immediate possession
of the property. Upon assumption, the debtor is required
to cure all arrearages within a reasonable period
of time, compensate the lessor for any actual pecuniary
loss resulting from such default, and provide adequate
assurances of future performance. Further, obligations
under an assumed lease are considered administrative
expenses with priority in payment.18
The 2005 revisions continue
the concept of providing the most favorable treatment
to lessors.19 Before the 2005 changes, the Code provided
that in all bankruptcy cases, an unexpired lease of
non-residential real property under which the debtor
is the lessee is automatically rejected if not assumed
within 60 days after the bankruptcy filing.20 In many
cases a debtor would routinely obtain multiple extensions
of the 60 day period, until the debtor determined
the value of the lease.
Now the Code has been
changed to provide that an unexpired lease of non-residential
real property is deemed rejected if not assumed or
rejected by the earlier of 120 days after the
petition filing or the entry of an order confirming
a plan. An additional 90-day extension may be obtained
by the debtor or lessor, but any subsequent extension
may only be obtained with the prior written consent
of the lessor.
In the event a lease
of non-residential real property is assumed by the
debtor and later rejected, a cap on the administrative
claim for damages has been enacted, at an amount equal
to the monetary obligations due under the lease for
two years after the rejection, less any amounts actually
received or to be received by the lessor from non-debtor
entities.21 Any damages for the balance of the lease
term are treated as an unsecured claim pursuant to
§502(b)(6).
Amendments have also
been made in an apparent attempt to clarify the obligations
of a debtor upon assumption of a real property lease
to cure non-monetary defaults, penalty rates and penalty
provisions.22 The changes appear to state that penalty
rates and penalty provisions relating to nonmonetary
defaults under any executory contract do not have
to be cured.23 Another amendment provides that if
it is impossible to cure a default of a non-monetary
obligation under an unexpired lease of real property,
then upon assumption, the default must be cured by
performance. Further, any pecuniary loss resulting
from the default must be paid within a reasonable
period of time.24
Leases of personal property
have new treatment, too.25 If the trustee rejects
a personal property lease, then the leased property
is no longer property of the estate and the automatic
stay of §362(a) is terminated.
If an individual debtor
in a Chapter 7 case desires to assume a lease, then
the debtor may provide the creditor with written notice
of the desire to assume. At the creditor's option,
it may agree to allow assumption and may condition
the assumption on the cure of any default pursuant
to the contract terms. The debtor bears the liability
for the assumption and not the estate. In an individual
Chapter 11 or 13 bankruptcy case, a lease is now automatically
rejected as of the conclusion of the confirmation
hearing, if not assumed in the confirmed plan confirmed
by the bankruptcy court.26
IV. Fraudulent Transfers
A bankruptcy trustee
is allowed under all chapters of the bankruptcy code
to recover assets fraudulently conveyed prior to the
filing of a bankruptcy petition.27 There has been
an expansion of creditors' rights in this area.
The reach back period
for which an avoidance action can be pursued has been
lengthened from one year to two years.28 This broadened
recovery tool applies only to a case commenced one
year after the effective date of the new law.
If an employment contract
(such as a key employee retirement plan) provides
a benefit to an insider, a transfer benefiting the
insider which is not in the ordinary course of business,
can be avoided as fraudulent.29 Normally, the recovery
of any fraudulent transfer in bankruptcy, requires
a showing of the transferor's insolvency. However,
this new kind of fraudulent conveyance relating to
insiders and employment contracts does not require
insolvency.
Another new fraudulent
transfer provision relates to self-settled trusts.30
It permits recovery of transfers up to ten years before
filing if made by the debtor to a self-settled trust
or "similar device." Two additional criteria
must be met: the debtor is a trust beneficiary and
the debtor made the transfer with the actual intent
to hinder, delay or defraud any entity to which the
debtor was or became indebted, on or after the transfer
date.31
For some, including
securities lawyers and investment bankers, the new
amendments provide additional changes that may be
of interest in the fraudulent transfer area. The definition
of a transfer has been expanded to include one made
in anticipation of any money judgment, settlement,
civil penalty, equitable order or criminal fine incurred
by, or which the debtor believed would be incurred
by (i) any violation of the securities law, or (ii)
fraud, deceit or manipulation in a fiduciary capacity
or in connection with the purchase or sale of any
federally registered security.32
Clearly, Congress intended
prospective debtors in bankruptcy, including fiduciaries,
whether they be key employees or investment professionals,
to be more accountable for their actions. Hence, the
changes to broaden the rights of bankruptcy trustees
to recover fraudulent transfers in bankruptcy are
now in place.
CONCLUSION
Beginning October 17,
2005, it will no longer be "business as usual"
in the bankruptcy courts. Those of us who have practiced
under the 26-yearold Code are now challenged with
a substantially new set of laws. We hope this article
gives you a head start in your return to bankruptcy
101.•
Endnotes:
1. The new law presents the most sweeping
changes since the Bankruptcy Reform
Act of 1978 created the new Bankruptcy Code (the "Code")
which followed
the Bankruptcy Act of 1898. In 1984, substantial amendments
were implemented
but they were not as comprehensive as the current
Amendments.
2. President Bush signed S.256 into law
on April 20, 2005.
3. Some parts of the new law were immediately
effective upon enactment, but most
provisions became effective for cases filed on or
after October 17, 2005.
4. When Judy Henry began her term as a
judicial law clerk to the Honorable James
G. Mixon beginning in January 1985, the 1984 Amendments
to the Code were
brand new. As Judge Mixon and I (Judy Henry) traveled
to and from divisions
outlying Central Arkansas, we discussed a specific
"new" code section
(they were all new to me) on each trip. The practice
was generally referred
to as "talk law."
5. See Associates Commercial Corp.
v. Rash, 520 U.S.953 (1997)
6. See 11 U.S.C. §1325(a)(9).
7. "Cramdown" refers to a debtor
paying only the value of the collateral and not the
amount of the debt.
8. See 11 U.S.C. §1326(a)(1).
9. See 11 U.S.C. §722.
10. See 11 U.S.C. §547.
11. See 11 U.S.C. §547 (c)(2).
12. See 11 U.S.C. §101 (14)(a) defining
domestic support obligations.
13. See 11 U.S.C. §547 (c)(7).
14. See 11 U.S.C. §547(e)(2).
15. See 11 U.S.C. §547 (c)(2)(9).
16. See 11.U.S.C. §547 (h).
17. See 11 U.S.C. §547(i).
18. See 11 U.S.C. §507.
19. See 11 U.S.C. §365.
20. See 11 U.S.C. §365.
21. See 11 U.S.C. §503 (b)(7).
22. See 11 U.S.C. §365 (b)(1)(A)
and (b)(2)(D).
23. See 11 U.S.C. §365 (b)(2)(D).
24. See 11 U.S.C. §365 (b)(1)(A).
25. See 11 U.S.C. §365 (p).
26. See 11 U.S.C. §365 (p)(3).
27. See 11 U.S.C. §548. Also, 11
U.S.C. §544(b) remains unchanged and permits
a fraudulent transfer to also be recovered by the
use of state fraudulent
transfer laws as well. Because Arkansas' fraudulent
conveyance laws
allow longer reach back than even the two years under
the 2005 code, state
law may remain the preferred fraudulent transfer recovery
vehicle in bankruptcy.
28. See 11 U.S.C. §548(a)(1) and
(b).
29. See 11 U.S.C. §548(a)(1)(B)(ii)(IV).
30. See 11 U.S.C. §548(e)(1)(A)-(D).
31. See 11 U.S.C. §548(e)(1)(D).
32. See 11 U.S.C. §548(e)(2)(A)-(B).
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