Monday, December 1, 2008

Bankruptcy Courts to Be Hit by Wave of Chapter 11 Reorganizations, Right? Think Again

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

A series of recent articles and blogs have highlighted yet another extremely adverse consequence of our current credit debacle, as it leaps down the economic food chain into corporate bankruptcies: Chapter 11's have quickly become much less favorable vehicles with which to reorganize businesses. This is because 1) the credit squeeze is also greatly diminishing the availability of debtor-in-possession financing, upon which reorganizing Chapter 11's depend, and 2) BAPCPA's Chapter 11 amendments have had some (surprise, surprise) highly detrimental unintended consequences. The resulting radical reduction in the ability of Chapter 11 to keep businesses relatively intact will add to the cycle of business closings, layoffs, and reduced consumer and commercial purchasing power.

Here are summaries of some of the better recent articles and blogs on this issue, with links to them:

A New York Times article of a couple of weeks ago with the headline, "Advantage of Corporate Bankruptcy is Dwindling," cited the examples of Chapter 11's by Linens 'n Things and Mervyns having to go the liquidation route because of the lack of debtor-in-possession financing, with the recent filing by Circuit City anticipated by many to go in the same direction. The problem is aggravated by the fact that in recent years the large DIP lenders have tended to be hedge funds and private equity investors, whose ranks have been thinned, and the survivors often now do not have money to lend, and if they do they want a quick return to assuage their own skittish investors, thus forcing liquidations instead of reorganizations.

"In the (Red): the Business Bankruptcy Blog" has recently had a couple of related stories:

"The Credit Crisis and DIP Financing" refers to the unavailability AND the greater expense of DIP (Debtor-in-Possession) financing when it is available, and the reality that more companies are more deeply leveraged, such as with "second liens, that many companies took on over the past few years when financing was easier to get," leaving these companies with "little or no unencumbered assets to offer a DIP lender as collateral." (So it's not just homeowners who were getting easy second mortgages!)

"The 2005 Bankruptcy Law Changes and Their Impact on Retail Reorganizations" focused on testimony in September 2008 by some bankruptcy professors and a Chapter 11 practitioner, Lawrence C. Gottlieb of the law firm Cooley Godward Kronish LLP, before the U.S. House of Representative's Subcommittee on Commercial and Administrative Law, of the Committee on the Judiciary, about "The Disappearance of Retail Reorganization in the Post-BAPCPA Era" . This testimony (the link is specifically to the testimony of Mr. Gottlieb) is a fascinating story of the perfect storm of "the credit crunch, the subprime lending crisis, the slowdown of the housing market and eroding value of retail commercial leases," all contributing to the near impossibility for retailers to emerge from Chapter 11 without liquidation. But notwithstanding these unprecedented economic forces, the testimony pinned much of the blame squarely on BAPCPA:
It is our experience that BAPCPA, with its numerous provisions impacting corporate insolvencies, has made it nearly impossible for retailers to emerge from Chapter 11 under any economic conditions. BAPCPA’s amendment to, and introduction of, some of the more crucial Bankruptcy Code sections affecting the retailer’s ability to meet its liquidity needs and obtain necessary postpetition financing – the lynch pin to any successful retail reorganization effort –has had a devastating effect on the retailer’s ability to reorganize.
The testimony reviews many changes to the Code which in combination, and particularly in the context of this unprecedented economic whirlwind, has had consequences that could not have been intended. By way of illustration, the changes to Section 365(d)(4) of the Bankruptcy Code now give DIP's an absolute maximum of 210 days from the date of filing to assume or reject a commercial real estate lease (without lessor's consent), instead of the prior 60 days PLUS "for cause" extensions routinely granted when the DIP was continuing to perform on the lease obligations.

[T]he fixing of an immutable deadline for the assumption or rejection of commercial real estate leases has dealt a knockout blow to prospective retail reorganizations. From a lender’s perspective, a retailer’s ability to routinely obtain extensions of the assumption/rejection period provided two critical protections. First, a lender could be assured that the retailer was provided with sufficient time to analyze the value of each individual store lease before making the critical decision to assume or reject the lease. Second, lenders were also assured that they would be provided with enough time to conduct a “going-out-of-business” (“GOB”) sale on the premises in the event a decision was subsequently made to terminate the reorganization process. Although both protections play important roles in a lender’s decision to provide postpetition financing, it is the latter protection which is most crucial. Absent the ability to conduct a GOB sale from the debtor’s store locations, a lender is deprived of the most commercially viable location to liquidate the collateralized inventory.
... .
Prior to BAPCPA, lenders were far more willing to finance a debtor’s reorganization, partly because the Bankruptcy Code essentially provided them with an indefinite period of time to assign the debtor’s below-market commercial leases to third parties at a premium in the course of a subsequent liquidation. Revised section 365(d)(4) appreciably lessens the residual value of a debtor’s commercial leases because lenders are left without sufficient time to market those leases in the event the reorganization stalls.

Sounds like the perennial "whipping boy," BAPCPA, deserves some more whipping.

by: Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys

Please note that this writer is not licensed to practice law in Oregon. This means that he is not legally permitted to give any legal advice or provide and legal services. This Bulletin and the entire contents of this website is written only for attorneys. and is not intended for the public. If any non-attorney is reading this, you must consult an attorney about ANYTHING you read here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

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