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Intended to Protect Creditors – Has Rule 6003 Fulfilled Its Purpose?
A number of changes to U.S. bankruptcy procedural rules went into effect on December 1, 2007. These changes were intended to level the playing field in response to the assertion that the previous rules strongly favored bankrupt debtors. In our last issue, we considered whether Section 503(b)(9) has fulfilled its intended purpose. The topic of this article is Bankruptcy Rule 6003.
What is Bankruptcy Rule 6003?
Rule 6003 was a new section added to the Federal Rules of Bankruptcy Procedure, which restricts the use of “first day motions” within 20 days after filing the bankruptcy petition.
Except in cases where adherence to Rule 6003 would cause the debtor “immediate and irreparable harm”, the rule states that “...the court shall not within 20 days after the filing of the [bankruptcy] petition, grant relief with respect to three areas.” Those being,
- Requests for authority to employ professionals pursuant to Rule 2014. This rule applies to attorneys, accountants and other 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 bankrupt estate, other than motions to use cash collateral or incur DIP financing per Rule 4001.
- Requests for authority to assume or assign any executor contract or unexpired lease.
Reasons for Enacting Bankruptcy Rule 6003
Rule 6003 was added to the Bankruptcy Code in response to the pressure of creditors who urged Congress to restrict relief available to debtors in the early stages of bankruptcy. It was intended to protect creditors’ rights by deferring rulings for 20 days on important fiscal matters 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.
- Protect the parties in interest.
- Ensure that full consideration could be given to matters that are likely to have a fundamental impact on the bankruptcy case.
- Pull some matters out of first day consideration so the court could focus on truly urgent matters.
- Allow all parties time to weigh in on matters that affected their specific interests.
First Day Motions
Once a company decides to file Chapter 11, there is normally an immediate flurry of activity, particularly by the debtor. The bankruptcy courts have been amenable to what are called “first day motions” to ensure a relatively smooth transition for the bankrupt company from business as usual.
Early motions typically made by the debtor include such things as:
- Retaining professionals (attorney, accountant, etc.)
- Paying employees
- Honoring gift cards and warranty claims
- Paying critical vendors
The rationale for allowing such motions has been that they maintain the value of the company and do not ultimately compromise any parties in interest.
Immediate and Irreparable Harm
Rule 6003 provides an “out” for the bankruptcy court to allow debtors to avoid the provisions of the Rule. This is accomplished by a clause that reads: “Except to the extent that relief is necessary to avoid immediate and irreparable harm [to the bankrupt].” Rule 6003 does not define immediate and irreparable harm. Nor does it describe the evidence debtors must provide, leaving considerable leeway for court interpretation.
While it is now required that the debtor/bankrupt introduce evidence into the record that makes a case of “immediate and irreparable harm”, the courts have been quite liberal in their interpretation of this portion of Rule 6003. In fact, courts have interpreted “immediate and irreparable harm” to mean:
- The possibility of serious diminution to the value of the debtor’s estate.
- Lack of debtor counsel during the first 20 days of a bankruptcy case, causing potential prejudice in a motion to dismiss.
- The possibility of any real prejudice to the debtor.
How the Courts Have Enforced Bankruptcy Rule 6003
Retention of Professionals
In general, the bankruptcy courts have allowed the debtor/bankrupt estate to retain an attorney despite Rule 6003’s 20-day bar. Three primary rationale for this are:
- Bankruptcy Rule 4001(b)(2) and (c)(2) provides for bifurcation of relief into interim and final components.
- A corporation may not appear in court, but requires legal representation to file first day motions for relief.
- Bankruptcy courts have the power to authorize retroactive employment of counsel and other professionals under their broad equity power.
However, this liberality does not normally extend to other professionals, including accountants.
Critical Vendor Payments
Critical vendor payments have been generally approved by the courts, regardless of Rule 6003 if the debtor can show that the:
- Vendor threatened to cut off provisions of post-petition goods or services if not paid.
- Vendor cannot be easily replaced.
- Vendor requires payment for prepetition services before post-petition performance will be guaranteed.
Selling Off Assets
The courts have also allowed debtors, under certain circumstances, to sell all or substantially all of their assets in the first 20 days after the petition was filed. The reason being that, in some instances, the prohibition of such sale on a debtor with rapidly depreciating assets could force a Chapter 7 (liquidation) bankruptcy, and thus destroy substantial value for creditors.
Has Rule 6003 Fulfilled Its Purpose?
While the language of Rule 6003 appears severe, the courts have been liberal in their interpretation of certain of its requirements. Whether or not it has fulfilled its intended purpose, therefore, remains a matter of discussion.
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