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By Tom Diana
Credit Research Foundation
When the [U.S.] Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 was passed, some in the credit community welcomed it as means to address the needs of trade creditors faced with distressed or bankrupted customers. Although the law was primarily aimed at the consumer credit card sector, the trade credit provisions were significant too. With the exception of several articles from the Credit Research Foundation claiming that this was bad legislation and potentially harmful to the fundamental reform of debtors, resulting in severely impacting the recovery for creditors (both secured and unsecured), the trade credit ramifications of BAPCPA got scant media attention. Now, after several years of being in effect, there is a movement to repeal some of the trade credit measures because they are regarded as working against the ability of some debtors to successfully reorganize under Chapter 11 of the Bankruptcy Code. Credit Research Foundation president, Terry Callahan, says, “Trade creditors should feel some sense of vindication through the affirmation of a second look at the law. Many business bankruptcies in the past several years have been adversely affected by BAPCPA, particularly in relation to the matters dealing with leases.”
Those who believe that BAPCPA’s trade credit provisions need to be repealed because they make it too difficult for debtors, especially retailers, to successfully reorganize under Bankruptcy Code protections, now have a legislative vehicle to do just that. HR 1942, known as “The Business Reorganization and Job Presentation Act of 2009,” was introduced by U.S. Rep. Jerrold Nadler (D-NY). The bill was introduced on April 2, 2009 and referred to the House Judiciary Committee. It has one co-sponsor as of May 26, 2009, who is Rep. Steve Cohen (D-TN). In a press release on the bill, Nadler said, “In an economy as depressed as ours, we must be cognizant of the many difficulties facing American businesses and avoid placing unnecessary hurdles in their paths. The Business Reorganization and Job Preservation Act of 2009 will remove some of the obstacles now hindering struggling businesses and inject a much-needed economic boost during this time of severe recession. It’s essential that we give retailers, which are often the job-providers of our communities, the means to reorganize and stay in business.”
Trade Credit provisions of BAPCPA to be Repealed
There were several major changes to the trade debtor-creditor relationship that were implemented under BAPCPA, which would be repealed if Nadler’s legislation is passed by Congress and signed into law by President Obama. These BAPCPA changes relate to: 1) the deadline to assume or reject non-residential real property leases, 2) utility deposits, 3) the Section 503(b)(9) administrative claim and 4) reclamation.
Under BAPCPA, debtors have a fixed deadline of a maximum 210 days for the assumption or rejection of non-residential real property leases. HR 1942 would reinstate the pre-BAPCPA practice of a 60-day deadline, but with the possibility of extensions by the Bankruptcy Court for “good cause”.
Utility Deposits by retail Debtors in Possession are required under BAPCPA Section 366, which some claim exhausts operating capital. HR 1942 would restore this provision to the pre-BAPCPA status that doesn’t require cash deposits by debtors in bankruptcy who can demonstrate they can pay their utility bills.
Section 503(b)(9) Administrative Claims
BAPCPA Section 503(b)(9) gives vendors an administrative expense priority claim for the value of any goods received by the debtor within a 20-day window prior to the bankruptcy filing, if the goods were sold in the ordinary course of the debtor’s business. Administrative priority claims take precedence over all unsecured and equity claims, so these claims will generally be of greater value. This provision would be repealed under HR 1942.
Reclamation would also be taken back to pre-BAPCPA days under HR 1942. Under BAPCPA, suppliers are allowed to take back or reclaim goods shipped within 45 days of a bankruptcy filing. This window to reclaim goods would be narrowed back to the pre-BAPCPA period of within 10 days of a bankruptcy filing.
Critics of BAPCPA Call for Easing of Trade Credit Provisions
According to the American Bankruptcy Institute, Chapter 11 bankruptcy filings nearly doubled to 9,272 in 2008 from 5,736 in 2007. Last year, 27 major retailers filed for bankruptcy protection, the most since 2001. One of the more recent and most dramatic bankruptcy failures was that of the nation’s number two electronics retailer, Circuit City, which closed more than 560 stores resulting in the loss of 34,000 jobs. Some critics of BAPCPA contend removing some of its trade credit provisions will help debtors get debtor in possession (DIP) financing and come out of bankruptcy as an operating entity as opposed to having to close its doors for good and liquidate its inventory and property.
BAPCPA – Good or Bad for Vendors?
Some who opposed BAPCPA claim that, to the extent it hinders debtors from successfully coming out of Bankruptcy, it eliminates the possibility of vendors making future sales with that customer. Opponents of BAPCPA see this as a bad, short-sighted strategy that concentrates on one-time gains to vendors, neglecting continuing future gains. On the other hand, some who support BAPCPA contend that it provides needed protections for vendors supplying distressed customers who are about to go through a bankruptcy. Vendors opinions on the matter may well be shaped by their experiences with BAPCPA, the kind of customers they sell to, and the nature of their products.
Reasons to Support HR 1942’s Gutting of BAPCPA
Attorney Larry Gottlieb is a strong supporter of HR 1942. Gottlieb is Chair of the Bankruptcy & Restructuring Group of the law firm of Cooley Godward Kronish LLP. On September 26, 2008 he delivered testimony before the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee. His testimony told members of the subcommittee and their staffs that repealing provisions of BAPCPA relating to trade credit could offer retailers a better chance to emerge from Chapter 11 bankruptcy the way they often did in the years before the BAPCPA amendments were passed and made effective. Unless BAPCPA is repealed, Gottlieb contends that more retailers will likely be forced into going out of business sales (GOB) instead of coming out of Chapter 11 and the number of retailers will continue to shrink.
While the economic recession, which officially began in December 2007, may have a role to play in retailers not being able to successfully emerge from bankruptcy, Gottlieb told CRF, “I think since October 2005 (the effective date of the BAPCPA) hardly any retailers reorganized and they didn’t reorganize because of BAPCPA and it’s more than just the economy.”
On the subject of leases, Gottlieb points out that it is important for retailers to have more time than the 210 days granted under BAPCPA to decide whether to keep or reject leases of non-residential property. Eliminating the 210-day time limit on leases imposed by BAPCPA would give the discretion back to the bankruptcy judges on how much time retailers have to make lease decisions. “It can be extended for a considerable amount of time in excess of the 210 days.” Gottlieb also noted that banks want ample time to liquidate inventory in which they have a security control. The 210-day time frame does not give retailers enough time to go through a successful reorganization, which usually forces banks into requiring the retailer to liquidate or sell its assets without any chance to reorganize. The banks reason that giving the retailer a chance to reorganize will reduce the necessary time they need to have their inventory sold pursuant to a GOB sale, before the expiration of the 210 days. “You can’t reorganize a company in 60 days,” Gottlieb said. “The banks are saying ‘I’m not going to help you reorganize. The inventory needs to be liquidated before you lose your leases’.” “There is not enough time to try to reorganize and also conduct a GOB sale,” he added.
Gottlieb also pointed to BAPCPA’s 503(b)(9) provision – which allows for goods sold within 20 days of a customer’s bankruptcy to be an administrative instead of an unsecured claim – as financially onerous to debtors trying to make it through bankruptcy. “That creates an enormous priority claim that didn’t exist before BAPCPA.”
Harry Miller, Senior Partner in the New York law firm of Weil, Gotshal & Manges LLP, testified before the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee on March 11, 2009. His testimony was entitled, “Circuit City Unplugged: Why Did Chapter 11 File to Save 34,000 Jobs?” In his testimony, Miller presented a detailed case for why BAPCPA should be repealed among other suggestions he made to make it easier for businesses, especially retailers, to make it through bankruptcy. He asserts that Chapter 11 of the Bankruptcy Code, which was conceived to save businesses while balancing the needs of creditors, has been drastically changed by BAPCPA. He said BAPCPA “clawed back the Bankruptcy Code protections that had been enacted to assist and enable a debtor to rehabilitate and organize its business.”
Reasons to Oppose HR 1942
Attorney Scott Blakeley, principal of the law firm of Blakeley & Blakeley LLP, doesn’t support repealing the trade credit provisions of BAPCPA. He notes that if bankruptcy fails and a liquidation results it will diminish the chances that a vendor gets paid on his 20-day claims with that customer. “Vendors are hurt with the uncertainty of their priority, let alone their non-priority, claims in a liquidation,” said Blakeley. He also pointed out that, getting goods returned to vendors under BAPCPA’s 45-day window for reclamation is often difficult. “Courts generally don’t allow the return of goods. The debtor’s lender often has a lien that prevents return of goods. Generally, reorganization where the debtor exits from bankruptcy is better for the vendor. However”, added Blakeley, “I strongly believe that the 503(b)(9) provision under BAPCPA is a necessary protection for vendors.”
Blakeley noted that liquidations of customers may present a number of other negative consequences for vendors, such as the greater concentration of control in the hands of the smaller number of customers in industries losing businesses. Less competition in an industry often leads to greater upward pressure on prices.
The reason eliminating the 20-day period for administrative claim status under 503(b)(9) of BAPCPA is not a good idea in Blakeley’s view, is because it gives leverage to vendors to get paid on that 20-day shipment when their customers file bankruptcy. He noted that terms are often adjusted to meet this 20-day window, which is an inducement to sell goods on credit terms. “If you don’t have that protection, then one consequence is that vendors may insist on personal guarantees, or letters of credit or cash in advance,” said Blakely.
Blakeley contends that BAPCPA may not be a significant factor for debtors that aren’t able to exit from bankruptcy. “The question is causation,” Blakeley said. “Are (BAPCPA provisions) truly the reasons for debtors failing to reorganize? Are they really the factors for these retailers failing?” He continued: “The only parties that have a 503(b)(9) claim are vendors providing goods. Many of them are not convinced that they are the reason that the debtor can’t get through bankruptcy.
Concerning private companies, Blakeley pointed out that they have all the information regarding whether or not they’re close to bankruptcy, so vendors who sell to private companies especially need the protection of 503(b)(9). “How do we know as vendors that the debtor is close to filing bankruptcy?” Blakeley said the same protection from being “surprised” by a bankruptcy is afforded to vendors with the reclamation provision of BAPCPA. “If vendors are not given the opportunity to protect themselves,” said Blakely, “they’re going to get nailed by bankruptcies by private companies.”
Before eliminating the protections afforded vendors through 503(b)(9), Blakeley said, “One would want to be certain that there is a connection between that provision and failed bankruptcies.” He cautioned that eliminating BAPCPA provisions may make it harder for companies to get the credit needed to sustain and grow their businesses.
The Debate Begins
If there is enough support for HR 1942, at least in the House Judiciary Committee, there will probably be hearings on it. During those committee hearings, parties on both sides of the issue will likely have an opportunity to voice their positions on the bill. So far, there appears two sides have already taken a stand on the issue. An April 2, 2009 article on Bloomberg.com entitled “U.S. Lawmakers to Consider Changes to Bankruptcy Law,” on the subject of the 120-day lease provision of BAPCPA stated, “The National Retail Federation has called for repealing the limit and returning to an earlier system, under which bankruptcy judges were allowed to extend the period indefinitely.” On the other side of the lease issue are landlords who, the article stated, “pressed for the 2005 lease limits and say they will resist changes because the deadlines allow them more flexibility to fill vacancies.”
There are other vested interests on both sides of the issue of whether HR 1942 should become law or never even make it out of committee. Congress is facing many important issues that may put this bill on the legislative back burner if enough political support for it doesn’t materialize. Gottlieb, a supporter of the bill, believes it has a good chance to be enacted. “The bad economy has helped focus Congress’ attention on the failings of BAPCPA,” Gottlieb said. “My view is something will happen to modify BAPCPA.”
CRF’s Terry Callahan said that looking at BAPCPA versus HR 1942 from his seat is a paradox. Regarding leases, he believes it is important for many debtors to have more time than the strict 210 days granted under the BAPCPA to decide whether to keep or reject leases of non-residential property. “Prior to BAPCPA,” said Callahan, “it was common practice for Bankruptcy judges to extend the time the debtor had to accept or reject a lease. Now, clearly decisions are being forced upon debtors that are often detrimental to a sound resolution of the case for both the debtor and creditors simply because there has not been enough time for the debtor to assess the situation.”
On the matter of 503(b)(9), Callahan feels that many creditors benefit by having their claim converted to an administrative claim, placing them ahead of other creditors. However, looking at it from the point of view of equitably reorganizing a debtor, he feels that this has given a distinct advantage to creditors who recently have removed some element of risk from their credit evaluation in favor of timing the shipment to coincide with a Chapter 11 filing to take advantage of the 20-day window of opportunity to have those recent shipments become an administrative claim.
Similarly, Callahan says that “Under BAPCPA, reclamation presents the creditors with an advantage and being an ‘old’ credit professional, I am in favor of any advantage a general, unsecured creditor can get over the debtor (or other creditors for that matter). However, the spirit of the Bankruptcy Law dictates that Chapter 11 is to reorganize and rehabilitate a debtor rather than to benefit a creditor.”
Reprinted with permission of the Credit Research Foundation (CRF) (www.crfonline.org), an independent, non-profit, member-run organization, consisting of business professionals dedicated to improving the practices of business-to-business credit through research, education, training and networking.