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The Bankruptcy Code Change: Attorneys and CPAs Speak Out

August 2007

New Jersey Business Magazine

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) was signed into law by President George W. Bush on April 20 of that year. While the Act may have been generally aimed at consumers (with provisions making it more difficult for individuals to avoid repaying their debts), it nonetheless directly impacts the corporate bankruptcy process. Since the business community has now had a chance to react to BAPCPA, New Jersey Business asks leading New Jersey attorneys and CPAs for their expert takes on what the Act really means.

Participating Attorneys:

Eugene J. Chikowski, shareholder and chair of the financial restructuring, bankruptcy and risk management practice group at Flaster/Greenberg, PC; and Joshua M. Gaffney, attorney and member of the financial restructuring, bankruptcy and risk management practice group at Flaster/Greenberg, P.C (Flaster/Greenberg's largest office is in Cherry Hill);

Robert E. Nies, a member of Wolff & Samson P.C's bankruptcy law department (The firm's New Jersey office is in West Orange);

Geraldine E. Ponto, director with Gibbons, P.C (The firm has offices in Newark and Trenton);

Andrew Sherman, vice chair of the creditors' rights/bankruptcy group at Sills Cummis Epstein & Gross, PC (the firm has New Jersey offices in Newark and Princeton).

Participating CPAs:

Kenneth DeGraw and John J. O'Donnell, partners with WithumSmith+Brown, P.C (In New Jersey, WithumSmith+Brown has eight locations);

Elizabeth Y. LaCorte, supervisor at Mercadien, P.C, CPAs, Princeton;

Matthew Schwartz, partner with Bederson & Company LLP, West Orange.

Q&A session with selected attorneys:

Question: What changes has the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) actually brought to the corporate bankruptcy process? How have your clients been coping with the changes?

Answer from Sills Cummis' Sherman: BAPCPA has made broad changes to the Chapter 11 process. Since it took effect, BAPCPA has changed the way that debtors approach the treatment of leases, limited the time periods for the exclusive right to file and plan, and restricted the incentives available for executive compensation. Mean
while, BAPCPA has also had a direct impact on creditors' rights by creating a new priority in payment for claims arising in the 20 days before the bankruptcy petition and a broadening of the defenses available to creditors when they face preference lawsuits by a debtor or trustee. BAPCPA also allows a court to order the change in membership of a creditors' committee and further requires a creditors' committee to provide information and access to non-committee members. Also, when there is a reasonable suspicion of fraud or dishonesty by current management or those that elect current management, the Office of the United States Trustee is charged with filing a motion to appoint a Chapter 11 trustee.

These changes have varying effects on a case-bycase basis; therefore any sweeping generalization about the overall effect of BAPCPA would be unreliable. The magnitude of BAPCPA's effects is also hard to determine at this point in time because of the slow Chapter 11 market and relatively small number of cases filed since BAPCPA. The true effect of the legislation will be seen when there is an economic downturn and much broader application of the amendments.

Question: From a debtor's angle, are the changes positive or negative?

Answer from Gibbons, P.Co's Ponto: Overall, BAPCPA's tighter timelines, decreased latitude in the bankruptcy courts and increased creditor rights during the course of the case restrict a debtor and thus are negative. While there are some benefits, such as the expanded lookback period from one year to two years for a debtor-in-possession or trustee to avoid a fraudulent transfer, that benefit was countered by other amendments eliminating a creditor's need to prove what is standard practice in the industry in: invoking the ordinary course of business defense to a preference complaint; prohibiting avoidance of transfers under $5,000; and requiring that complaints to avoid alleged transfers between $5,000 and $10,000 must be brought in the defendant's home court.

Answer from Wolff & Samson P.Co's Nies: It is a bit premature to gauge the impact of BAPCPA amendments on business debtors. The recent trend, however, of greatly reduced business filings, would appear to be less a reaction to the BAPCPA amendments and more a function of historically low interest rates and an abundance of capital chasing limited business opportunities. That trend preceded the enactment of the BAPCPA amendments and continues even now. Until that business climate changes, the true impact of the BAPCPA amendments will remain uncertain.

Notwithstanding that uncertainty, with the limitations upon a debtor's "exclusivity period" in which to propose and confirm a plan of reorganization, as well as the time periods to assume or reject commercial leases, we predict that the overall cost of filing a Chapter 11 bankruptcy likely will decrease under BAPCPA. Apart from the builtin cost savings from some of the timesensitive BAPCPA amendments, there seems to be today a heightened interest of all parties to voluntarily curtail the enormous expense of Chapter 11, at least before Congress undertakes some mandatory provisions to curtail what are perceived by many to be runaway professional fees. Hopefully, the BAPCPA amendments and a little professional self restraint will result in a more affordable, viable alternative for the middle market businesses that traditionally simply cannot afford - and survive - the Chapter 11 reorganization process.

Question: Given BAPCPA's realities, what advice would you give businesses that may be facing bankruptcy?

Answer from Flaster/Greenberg's Chikowski and Gaffney:From the perspective of a business that is contemplating bankruptcy, it's very important that it develop a plan for how it intends to emerge from bankruptcy and carefully determine how it wants to get there. This isn't new advice, but BAPCPA really demands that businesses consider how their bankruptcies will be implemented and have contingency plans to ensure that their goals are met.

Answer from Gibbons' Ponto: Be prepared for multilateral pressure, negotiation and expense. Even before the enactment of BAPCPA, it was important to have an exit strategy in mind and financing in place at the time that a business filed for reorganization under Chapter 11 of the bankruptcy code. It was always important to work with committees of creditors and equity security holders to achieve a confirmable plan. Since BAPCPA,
it is absolutely essential to have sufficient cash to operate and a plan to reorganize that can be achieved under the maximum timelines provided under the Bankruptcy Code, as amended. Professionals employed with court approval for all constituents are compensated at the expense of the debtor corporation. If consensus cannot be reached and litigation results, protracted litigation will consume precious time and resources that should be devoted to accomplishing a confirmable plan under truncated tlmelines presented by BAPCPA. Management of a debtor should take a critical look at the condition of Its books and records, its past compensation practices and its objectives going forward, because they will be closely scrutinized and evaluated during the Chapter 11 process. The expectations of the creditor body must be considered and satisfied to the extent of a debtor company's financial ability to do so and within the strictures
of the Bankruptcy Code. If the debtor's management's practices and objectives do not measure up and pass muster under the scrutiny of the United States Trustee, the committee or committees, secured creditors and independent unsecured creditors who choose to take an active role in the case and the court, control may be lost to a trustee or examiner. Additionally, costs will be compounded, and the case may be converted to a liquidation or dismissed.

Q&A Session with CPAs:

Question: From the accounting angle, what changes has BAPCPA brought about?
Answer from Bederson's Schwartz:
Because of the strict, limited time frames BAPCPA imposes on certain activities - such as assuming or rejecting leases and plan formation - cash flow planning has become paramount.
We have found more reliance not only on pre-petition cash flow planning, but also strict budgets for short time frames, typically 4 to 13 weeks. At the same time, cash flow has become more important, it has also become more difficult given the ability of certain pre-petition creditors to claim administrative status where under prior law they were general unsecured claims. This means that upon confirmation, these "administrative claims" must be paid in full, rather than on a reduced basis, as with other creditors. In addition, debtors now typically must use cash as a utility deposit after filing bankruptcy rather than some other treatment, as in the past. Also, real-time reporting of operating results has become critical, especially in retail cases, because of the need to quickly identify underperforming locations so leases can be timely rejected.

On the tax side, certain state and local tax claims have been moved up on the priority of payments. For example, underprior law, proceeds from property subject to unavoidable tax lien were distributed to certain other parties before any distribution could be made to the tax authority. Under BAPCPA, tax liens arising from ad valorem tax on real or personal property are no longer subordinated. In addition, for tax claims entitled to interest, the rate used to be calculated at an approximation of market rates. Under BAPCPA, the rate to be used is determined under applicable nonbankruptcy law. While there is some consensus that federal (i.e., Internal Revenue Service) interest rates bear some relationship to market rates, certain states require interest at rates that far exceed the market.

Question: When it comes to BAPCPA, what are some examples of how you have been advising your clients

Answer from DeGraw and a'Donnen of Withum Smith+Brown: To borrow the Boy Scout motto, "Be Prepared." The act's rules changed the landscape and gives the business a limited exclusive window of opportunity to reorganize. The more that negotiations and plans can be formulated and prearranged before filing, the greater the chances of a successful reorganization. Secondly, consider alternatives such as an Assignment for the Benefit of Creditors, also known as a State Bankruptcy, when liquidation is the chosen course of action.

For individual debtors, the advice is a reflection on the cause of the financial difficulty. While a filing can provide a fresh start, it is not a cure for an unsupportable lifestyle, nor can it change financial bad behavior.

Finally, engage professionals early. This also applies as well to companies whose customers are facing financial difficulty. A professional team of accountants and attorneys can provide a fresh viewpoint, negotiate settlements and help avoid preferential payments situations. In addition, the professionals may have other viable options that would prevent the need to file for the court's protection.

Answer from Mercadien's LaCorte: When advising clients, they need to know that BAPCPA is "creditor friendly." Therefore, it's important for debtor companies to understand their creditors and position. The debtor companies need to modify their focus from the protections the bankruptcy process offers them, to the increased protections provided to creditors.

For instance, some Internal Revenue Service representatives say they would be attending more creditor meetings. Of particular interest to them is §362 of
the Federal Bankruptcy Code ("the Code"). A provision was added so that a governmental unit's set-off of an income tax refund against a claim is not a violation of the automatic stay.

The change that affects most debtor companies is the case of nonresidential leases of real property. pervisor at Mercadien. Generally, there is a 120-day window which can be extended an additional 90 days upon court order. And subsequent extension requires the lessor's consent.

Robert E. Nies, can be contacted at Wolff & Samson PC, One Boland Drive, West Orange, New Jersey 07052, email address: or phone number:(973)530-2012.

Reprinted with permission from New Jersey Business Magazine