1. BANKRUPTCY IN THE US
Bankruptcy in the US:
The Need to Know Concepts Part I
David Conaway gives us a summary
of the “need to know” bankruptcy
concepts as they impact creditors
in business insolvencies in the US
Chapter 11 vs. Chapter 7 or continuing a lawsuit, entering or
Chapter 11 is technically used for
enforcing a judgment, terminating “US Bankruptcy Courts
contracts or taking any other action to
bankruptcy reorganisations, while Chapter
enforce payment. There are limited
almost always approve
7 applies to liquidations. Chapter 11 has
been increasingly used as a tool to
occasions where the Bankruptcy Code DIP financing as
permits a creditor to obtain “relief from
liquidate business assets as a “going
stay” to proceed. necessary to allow a
concern”, hence the frequent “liquidating
11”. By contrast, in a Chapter 7 debtor to continue
First day motions
liquidation, the appointed trustee is not operating”
permitted to operate the business, except Debtors usually file “first day” motions
in rare circumstances. Accordingly, any which are scheduled for hearing a day or
going concern value can be achieved only two after the bankruptcy filing. Most of collections, unless the lender consents or
through a “liquidating” Chapter 11. the “first day” motions are procedural and the Bankruptcy Court permits the debtor
The US Bankruptcy Code has unique administrative, but there are also to use cash collateral over the lender’s
provisions allowing debtors to sell assets substantive motions, such as the debtor’s objection.
free and clear of liens (with liens attaching motion to approve debtor in possession or Bankruptcy Courts almost always
to proceeds), which enable a debtor to “DIP” financing. approve DIP financing as necessary to
deliver “clear” title to prospective buyers. The Bankruptcy Code provides that allow a debtor to continue operating,
pre-petition liens on collateral do not although creditor objections can modify or
Automatic stay extend to property acquired by the debtor eliminate objectionable provisions of the
post-petition. In addition, the Bankruptcy DIP financing. As an alternative source of
To promote the bankruptcy concept of cash, Debtors unable to obtain DIP
Code provides that the debtor may not
providing “breathing room” to debtors, financing may seek Bankruptcy Court
use as working capital the lender’s “cash
the US Bankruptcy Code enjoins any permission to use the lender’s “cash
collateral”, which is the cash generated by
action to collect pre-petition debts owed to collateral” over the lender’s objections.
inventory sales and accounts receivable
creditors. This would include commencing
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2. BANKRUPTCY IN THE US
Doing business with a Set-off and recoupment
Chapter 11 debtor “An often overlooked An often-overlooked remedy, set-off arises
remedy, set-off arises from the settlement of mutual debts or
Upon the filing of a Chapter 11 by a
accounts owed between a debtor and a
customer, vendors must determine from the settlement of creditor. The Bankruptcy Code codifies
whether to sell to the debtor post-petition.
this common law remedy and in fact
To avoid the inherent risk of a Chapter mutual debts or provides that the creditor has a secured
11, vendors often sell on a cash before
delivery or “CBD” basis. The Bankruptcy
accounts owed between claim to the extent of the value of its set-off
claim. The debts owing must be owed to
Code treats credit extended to a Chapter a debtor and a creditor” and from precisely the same legal entities
11 debtor in the ordinary course of
and the debts must arise either both pre-
business as an administrative expense Secured, administrative and priority claims petition or both post-petition. The debts
priority claim, which are generally paid in are generally paid in full while unsecured do not, however, have to arise out of the
full, absent an “administrative insolvency”. claims are rarely paid in full. Equity same transaction. The exercise of a set-off
Where vendors have open purchase interests are almost always canceled at no remedy requires relief from the automatic
orders from debtors that arose prior to the value. stay from the Bankruptcy Court.
Chapter 11 filing, that provide for post- There are many exceptions to the Recoupment is similar to set-off, except
petition shipment by the vendor, a general rules, particularly in the case of an that the mutual debts must arise from the
practical solution is to require the “administrative insolvency”, where the same transaction.
purchase orders to be re-issued post- value of the debtor’s assets are insufficient
petition. Many debtors, particularly in to pay the lender’s claims and also the Disclosure
larger cases, file a “first day” motion administrative claims, much less claims The Bankruptcy Code provides all
seeking an order from the Bankruptcy “below the line”. creditors various substantial rights to learn
Court granting administrative claim details about the debtor’s financial
priority for post-petition shipments on condition, historical transactions and
Creditor remedies
pre-petition orders, to avoid the re- prospects for reorganisation.
issuance of purchase orders. 20-Day administrative claim
Involuntary petition
Section 503(b)(9) to the Bankruptcy Code
Schedules of assets and provides that sellers of goods are entitled Section 303 of the Bankruptcy Code
to an administrative priority claim for the permits three or more creditors to file an
liabilities and statement of involuntary petition against a debtor, in
value of goods delivered to a debtor within
financial affairs 20 days prior to the bankruptcy filing. either Chapter 7 or Chapter 11, if certain
The Bankruptcy Code imposes a Upon a motion by the creditor, most requirements are met. The requirements
requirement on every debtor to file courts have allowed vendors an are that the aggregate debt owed to the
detailed Schedules of Assets and Liabilities administrative claim for the value of goods three or more creditors is at least $13,475
as well as a Statement of Financial Affairs. delivered within 20 days prior to the filing. for 2008, such debts are not contingent as
The Schedules of Assets and Liabilities list Courts have been less willing to order to liability or subject to a bona fide
the debtor’s assets and values and detail immediate payment of 20 day dispute, and the debtor is not generally
the names of secured and unsecured administrative claims, instead allowing paying its debts as they come due.
creditors, the amount of the indebtedness them to be paid in connection with plan During the “gap” period (time period
and whether or not the indebtedness is confirmation or in connection with the sale between the date of the involuntary
disputed. The Schedules also contain a list of substantially all of the debtor’s assets. petition and the date a Bankruptcy Court
of equity holders, contracts to which the enters an order for relief), there are
debtor is a party, and transfers made to Reclamation pertinent rules on dealing with an entity
insiders and non-insiders prior to the Reclamation is based upon a state law during the gap period.
bankruptcy filing. remedy arising from the Uniform
Commercial Code’s provisions on sales of Part II of this article will address issues
Claim priorities goods, which allows a vendor to reclaim including additional creditor remedies,
The Bankruptcy Code sets forth clear goods delivered to a customer (or stop executory contracts, proofs of claim, Section
priorities of payment or entitlement to goods in transit), if the seller learns of the 363 sales of assets, plans of reorganisation,
payment by types of creditors or claims as customer’s insolvency. avoidance actions and Chapter 15 regarding
follows. cross-border insolvencies. A more compre-
Critical vendor
• Secured creditors hensive version of this article is also
Critical vendor is a creditor remedy based available directly from the author,
• Administrative claims on a theory that a particular vendor is so
• “Gap” period claims dconaway@slk-law.com.
essential to a debtor’s ability to continue
• Limited employee wage claims operating that without the uninterrupted
• Certain employee benefit contribution DAVID H
flow of the seller’s goods, the debtor CONAWAY
claims cannot continue to operate and thus has
• Limited consumer deposit claims for Attorney at Law,
no realistic chance of a successful Shumaker, Loop
the purchase of goods or services reorganisation. In these instances, a
• Certain government tax claims & Kendrick LLP
bankruptcy court has broad authority to
• General unsecured claims order relief that facilitates a successful
• Equity interests reorganisation.
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