Creditworthy News - 6/11/09 Edition 

CHAPTER 11 - WHAT THE PUBLIC NEEDS TO KNOW
By Robert Bernstein, Esq.
http://www.bernsteinlaw.com/

Since the late 1970s, the public really started to learn about Chapter 11 and how it works in "big companies." Today, of course, we are hearing about the Chrysler Chapter 11 and the likely GM Chapter 11. Whether the cases are quick (as promised) or longer (as likely), it would be good to revisit the basics of Chapter 11 so we can all better understand what is happening.

The Bankruptcy Code is a federal statute (Title 11, United States Code – the "Code"). Chapter 11 is the business reorganization chapter of the Code. The company that files (Chrysler) is the Debtor. If the Debtor is still in control of its business (as in most Chapter 11 cases), it is called a Debtor-in-Possession or DIP. The people who are owed money are called creditors. The people (or companies) who own the debtor (stockholders or otherwise) are called interest holders. The Judge is the Judge or the Court. Everyone has a lawyer (or several). In large and complex cases, the Court often appoints an Examiner (to investigate) or a Trustee (to examine and control). If a Trustee is appointed, he or she takes control of the assets and the business. The Debtor is then out of possession and is no longer a DIP.

Chapter 11 allows Court-supervised restructuring. The Code permits the changing of contracts over the objection of the other parties. Debts, supplier and dealer agreements are contracts, to name a few. The Court supervises the process. The parties (all of the stakeholders) all get to have their say and the Court tries to balance the interests under the Code.

Debt comes in different flavors. Senior (or secured) debt has the right to take specific assets if not paid. Priority unsecured debt is that debt which has no right to specific property, but has been given priority under the Code. Consumer deposits, wages, and some employee benefits are examples of things that get paid before other, regular, unsecured debt. Non-priority unsecured debt would be things like amounts owed to suppliers for deliveries prior to the bankruptcy however, under some circumstances there are some supplier deliveries that are given priority. Debts with no special treatment are referred to as general unsecured debts.

The costs of running the Chapter 11 and the Company are usually entitled to a very high priority in a distribution. These include expenses incurred in the ordinary course of business, as well as the professional fees of representatives of "official parties" in the case. These include the lawyers, financial advisors, and investment bankers for the Debtor, any official committees, and any Trustee or Examiner.

If a contract has already been performed by one side or the other, the other party is just entitled to money and is a creditor. If there is still something to be performed by both sides, then the contract is "executory." Unfulfilled orders is an example of an executory contract. If the contract is executory, then the Debtor often gets to decide if it wants to keep the contract or not. This is known as "assuming" or "rejecting" a contract. Generally, the Debtor gets to make this choice, subject to Court approval. If the debtor’s decision unreasonably burdens the company (harming other creditors), the Court may not approve the decision.

If the debtor decides to assume the executory contract, it is usually required to cure any defaults and show that it can perform in the future. The debtor gets the benefits and burdens of that contract after the bankruptcy. If the Debtor chooses to reject, the other party may be entitled to damages, just as if the company had breached a contract outside of bankruptcy. The damages are usually treated as pre-bankruptcy, unsecured debts and are added to the other debts of the Debtor. Collective Bargaining Agreements (Union contracts) have additional protections, but can eventually be modified or rejected by the Debtor.

Sales of Assets. Although unclear in the current stories about Chrysler, we are expecting a sale of some of the operating assets of the Debtor. Section 363 of the Code allows the sale of assets free of liens of the secured creditors. These sales are often referred to as a "363 Sale."

Plan of Reorganization. This is the Debtor’s proposed restructuring. Everyone (and in this case that includes the government) gets to weigh in on the Plan and try to improve its respective position. This is the document that says who gets what and what the company looks like when it comes out of the bankruptcy. Sometimes the Plan is negotiated before the bankruptcy case is filed and then the Plan is filed at or near the time when the bankruptcy petition is filed, along with the required approvals of creditors. When that works, the case can be called a pre-packaged bankruptcy. When it doesn’t work, the Court still considers the proposal of the creditors and decides if it meets the tests of the Code and can be approved.

Why couldn’t this be done outside of bankruptcy? Outside of bankruptcy, all parties must agree to the change of contracts and debts. In bankruptcy, the Court can bind reluctant parties under certain circumstances. It is often hard to get unanimous consent in a class of creditors (like bondholders or trade vendors). Chapter 11 allows the Court to force a treatment on a class when more than half the creditors vote and more than 2/3 of the amount of money voting, approves the treatment. Sometimes the Court can approve a plan when these tests aren’t met, but it requires a much more difficult burden in the Plan proponent.

Why is Chapter 11 so expensive? Lehman Brothers estimates run over $700 million. The Debtor’s professional has to handle everything and fight with everyone. Every official party (committee, Examiner, Trustee) have professionals that get paid by the Debtor and must participate in every aspect of the case to make sure their constituency is represented. So every time the Judge hears anything in the case, there are several (or dozens) of lawyers in the court getting paid by the Debtor.

Why does it take so long? They can be very complicated. A company like Chrysler didn’t get created overnight and didn’t get into this mess overnight. It can take months or years to figure out how to fix it or unwind it if it can’t be fixed. The Code has reasonable time limits built in, but things can get messy. If everyone agrees in a Pre-Pack, it can move through in 60 days or so. Some large cases have. Here, it is likely to take much longer. Who knows?

Expect stories about how Chrysler can jettison dealer agreements (which it can), pay some suppliers and not others (which it can), close plants and end supplier relationships (which it can). If there is a good restructuring plan which just needed the power of the Court to bind reluctant creditors, it might move pretty smoothly. With Lenders being asked to write off billions of dollars, expect there to be some significant relocation.

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