Published in the October 2005 issue of Business NH
Magazine
Seeing Red
The new bankruptcy act is both good and bad news for NH’s small
businesses.
By Joshua E. Menard
The new bankruptcy act that goes into effect this month will not only affect
consumers, but will have implications for commercial transactions, small
business bankruptcies and the rights of creditors.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 makes it
much tougher to declare bankruptcy, which has pros and cons for small business
owners across NH.
Easier Reimbursement
There's good news for small businesses that are owed money. The Act will make
it easier for them to be reimbursed in full, as a so-called "administrative
expense," if they delivered their goods or services, in the ordinary course of
business, 20 days before a company files for bankruptcy protection. Reclamation
rights have also been broadened to cover goods delivered to the debtor 45 days
prior to the petition date.
Defense Against Preference Actions
Preference actions have also
been overhauled. A preference payment is one made by a debtor to a creditor
during the 90-day period immediately preceding the debtor's bankruptcy filing.
In providing for recovery of preference payments, the Bankruptcy Code seeks to
prevent a debtor from "preferring" one creditor, or a select group of creditors,
over others.
The Act makes it much easier for creditors to defend against preference
actions. A key change is the raising of the threshold for bringing a preference
case. Alleged preferential transfers to a creditor that aggregate less than
$5,000 are no longer avoidable. The previous limit was $600 and only applied to
consumer debts.
Also, preference actions concerning a consumer debt from a non-insider (an
insider is usually a relative of a consumer debtor, or a director, officer or
partner of a business debtor) of less than $15,000 or any other debt from a
non-insider of less than $10,000 can only be brought in the creditor/defendant's
home district. Gone are the days of a non-insider business creditor in NH being
sued for a small preference payment in a Delaware bankruptcy case and having to
ante up simply because the cost of defending in Delaware was too high. Now the
Delaware plaintiff will have to come to NH to pursue the preference action.
Most of these small preference cases will probably not be pursued, which is
good news for the creditor and not so good for the debtor's estate.
Easier to Collect Debts
The new law will also make it easier
for small businesses to collect debts from individuals who file for bankruptcy
protection. Under the Act, many individuals will no longer be eligible to file
for relief under Chapter 7. Instead, they will have to file under Chapter 13,
which commits them to a payment plan requiring them to pay back a portion of
their debts over a five-year period.
Pro-Landlord Leases
Current bankruptcy law allows a trustee or
debtor-in-possession 60 days to decide whether to assume or reject a commercial
lease, with extensions allowed "for cause." In most bankruptcy courts,
extensions are liberally granted as long as the trustee or debtor-in-possession
is making the payments due under the commercial lease.
The act makes a dramatic change. The initial period in which the trustee or
debtor-in-possession has to decide whether to assume or reject a commercial
lease is expanded to 120 days, but the trustee or debtor-in-possession will no
longer be able to get endless extensions, even if the debtor is faithfully
paying the rent. Only a single 90-day extension will be allowed, if "cause" is
established, without the landlord's consent. This change is certainly
pro-landlord.
Once a commercial lease is assumed, all future rental obligations are
classified as administrative claims, with priority over most other claims. As a
result, even if the case eventually fails, the lease obligation, subject to a
two-year cap, will be paid before unsecured creditors see any distribution.
Retention Pay Capped
There have been high-profile bankruptcy cases where company management, prior
to the bankruptcy case, received bonuses or new employment agreements with
significantly enhanced compensation and benefits, including severance pay. Under
the Act, creditors will be able to recover a transfer to an officer or director
under an employment contract if the transfer was not made in the ordinary course
of business. It will be much harder for management to effectively give itself
substantial compensation benefits shortly before a bankruptcy case is
filed.
Filing for Protection Is Ugly
The Act isn't at all friendly to small businesses that have to file for
bankruptcy protection. In Chapter 11, debtors with less than $2 million in debt
will be subject to the Acts' new "small business" provisions. The new provisions
require additional paperwork and reporting burdens and the company must have its
books and records examined by a bankruptcy trustee to ensure that the company
has a plan to succeed. If the trustee determines that the business doesn't have
a good chance of surviving, he or she can move the case from Chapter II to
Chapter 7. Under Chapter 7, a company's assets are liquidated to payoff
creditors.
Joshua E. Menard is an attorney with Preti Flaherty in Concord. He can be
reached at jmenard@preti.com or 603-410-1500.
