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Changes to the United States federal procedural rules for bankruptcies occur almost every year. Those effective December 1, 2007, however, are particularly important because they focus on making the bankruptcy process more equitable for both creditors and debtors.
Three of the most significant changes and how they impact creditors in a bankruptcy are explained here. These amendments apply to all bankruptcy cases pending on December 1, 2007, as well as all new cases filed on or after that date.
Bankruptcy Rule 3007 -- Objections to Claims
Rule 3007 governs objections to creditor claims filed in a bankruptcy case. Large bankruptcies in particular require the DIP (debtor in possession) or bankruptcy trustee to address objections to a large volume of creditor claims.
Before the amendment to Bankruptcy Rule 3007, the common practice was to object to groups of claims – which sometimes numbered in the hundreds or even thousands – under a single pleading called an omnibus objection. A large bankruptcy case might involve a series of such objection documents. As a result, reference to an individual creditor’s claims would be buried somewhere in the voluminous paperwork.
While this made the claim objection process easier for the DIP, creditors were placed under a heavy burden to make timely response, or their claims would be automatically disallowed. This meant that the creditor, or his attorneys, had to wade through all of the omnibus objections documentation to determine whether their claims were included.
How Amended Rule 3007 Impacts Creditors Rights
Amended Rule 3007 is intended to help individual creditors by:
- Restricting the use of omnibus objections to limited instances, generally involving technical or procedural, rather than substantive challenges; for instance: duplicate claims, claims filed in the wrong case, claims not timely filed, etc.
- Requiring that objections to claims on substantive grounds be filed individually, one claimant at a time. (Debtors are allowed to combine objections to claims filed by the same entity.)
- Restricting the number of claims that can be addressed in a single objection to 100.
- Requiring that all claimants covered in the objection be listed in alphabetical order, and be cross-referenced by claim number; and that the title of the document state the basis for the objection, describe the objector, and the reason for the objection.
- Making “books and records objections” ineligible for inclusion within omnibus objections. These objections refer to situations where the amount claimed by a creditor is inconsistent with the amount shown on the debtor’s books and records. Under the new rule, these must be dealt with individually (except where there are multiple such objections against a single creditor).
A caveat to Amended Rule 3007 is that any specific bankruptcy court can opt out of the new requirements if they are addressed by a local rule, whether or not the local rule is in direct conflict with Rule 3007. Example: The Bankruptcy Court for the District of Delaware has determined that Delaware bankruptcy cases will continue to be covered by Local Rule 3007-1, rather than amended Rule 3007.
A similar amendment to Bankruptcy Rule 6006 restricts the use of omnibus motions dealing with executory contracts and unexpired leases.
Bankruptcy Rule 4001 -- Relief from Automatic Stay; Prohibiting or Conditioning the Use, Sale, or Lease of Property; Use of Cash Collateral; Obtaining Credit; Agreements
Rule 4001 sets forth new procedural requirements for applications related to the automatic stay, use, sale or lease of property under Section 363 of the Bankruptcy Code, and use of cash collateral or obtaining post-petition credits.
One of the primary areas covered in this rule relates to the ability of the bankruptcy estate to encumber estate assets early in the case. Some companies filing bankruptcy will pre-negotiate arrangements with secured creditors or lenders to use cash that was previously pledged as collateral or to obtain post-bankruptcy (DIP) financing. In exchange for allowing the bankruptcy company access to this funding, the secured creditors or lenders generally obtain liens on the assets of the estate. This can tie up funds that might have originally and ultimately been available to repay unsecured creditors’ claims.
How Amended Rule 4001 Impacts Creditors' Rights
The amendment to Rule 4001 makes it easier for creditors to understand the key aspects of any post-bankruptcy collateral arrangements, and to thus formulate more cogent objections. The DIP or bankruptcy trustee is required to give more detailed disclosure of the terms and conditions of agreements by including with the motion seeking bankruptcy court approval:
- A statement/synopsis (not to exceed 5 pages) that concisely describes the provisions of the agreement.
- Cross-references within the motion to the location of key provisions in the agreement.
Bankruptcy Rule 6003 – Interim and Final Relief Immediately Following the Commencement of the Case
It is a common practice among bankrupt companies to seek immediate (first day) authority to pay critical vendors or employee wages, handle pre-bankruptcy claims, retain professionals, sell and/or use estate assets, and assume contractual obligations.
Rule 6003 is actually a new section, added to the Federal Rules of Bankruptcy Procedure, restricting the use of “first day motions” This section states that “except and to the extent that relief is necessary to avoid immediate and irreparable harm, the court shall not, within 20 days after the filing of the [bankruptcy] petition, grant relief with respect to three areas:
- Requests for authority to employ professionals.
- Requests for authority to pay pre-bankruptcy claims of critical vendors or other creditors, or to use, sell, lease or incur obligations regarding the property of the bankruptcy estate, other than motions to use cash collateral or incur DIP financing.
- Requests for authority to assume or assign any executory contract or unexpired lease.”
How New Rule 6003 Impacts Creditors’ Rights
This new rule protects creditors’ rights by deferring rulings on important fiscal matters for 20 days in order to:
- Stem the flow of cash from bankrupt entities at the beginning of the bankruptcy.
- Provide adequate time for appointment of a creditors’ committee and its retention of counsel.
Effects of These Three Changes to U.S. Bankruptcies
The actual impact these and other changes to the Federal Bankruptcy Rules will have on individual cases is yet to be determined. To view all of the December 2007 changes, visit the Cornell Law School’s web site: Federal Rules of Bankruptcy Procedure.
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