On December 8, 2014, the American Bankruptcy Institute (“ABI”) Commission to Study the Reform of Chapter 11 (the “Commission”) issued its Final Report and Recommendations (the “Report”). The Report proposes a number of important changes to Chapter 11.[1]
The Commission was formed in 2012 to respond to shifts in the financial markets, corporate structures and credit and derivatives products since the Bankruptcy Code’s adoption in 1978 and is comprised of leading bankruptcy practitioners, professors and judges. The Report is the result of an in-depth, two-year review of Chapter 11 by the Commission and 13 separate Advisory Committees. The “Recommended Principles” proposed in the Report — if enacted by Congress — would alter significantly the U.S. bankruptcy process for all debtors, creditors and parties in interest.
The most notable Recommended Principles include the following:
DIP Financing
- Material limitations should be imposed on postpetition financing provisions that call for a roll up or pay down of prepetition debt. (Report at IV.B.2).
- The use of extraordinary provisions frequently found in postpetition financing documents, including provisions requiring that the debtor take material actions to satisfy lender conditions, such as filing a plan or selling assets, should be limited. In particular, such provisions should not be permitted in interim orders and should not apply within the first 60 days of a chapter 11 case. (Report at IV.C.1).
- Postpetition financing should not be approved if it grants a lien on or any interest in the estate’s avoidance actions. (Report at IV.B.2).
Section 363 Sales
- Section 363 sales of all or substantially all of a debtor’s assets should be expressly authorized and are referred to in the Report as 363x sales. (Report at VI.B).
- Section 363x sales should meet certain standards that are consistent with certain standards imposed on reorganization plans under Section 1129 including that the sale complies with the applicable provisions of the Bankruptcy Code, the sale has been proposed in good faith, and the debtor must retain proceeds sufficient to fund administrative expenses incurred through the closing of the sale. (Report at VI.B).
- A moratorium should be imposed on Section 363x sales within the first 60 days of a chapter 11 case, absent clear and convincing evidence of compelling circumstances. (Report at IV.C.1).
Securities Contracts and Safe Harbor Provisions
- Safe harbor protection under Section 546(e) from avoidance actions for beneficial owners of privately issued securities of the sort used in LBOs should be removed. (Report at IV.E.1).
- Safe harbor protection for certain repos should be withdrawn by either reverting to the pre-2005 Bankruptcy Code definitions of “repurchase agreement” and “securities contract” or excluding from safe harbor protection repos that are the equivalent of committed financing arrangements for mortgage loan portfolios. (Report at IV.E.2).
- Walkaway clauses in qualified financial contracts should be unenforceable. (Report at IV.E.5).
- Ordinary physical supply agreements should be excluded from safe harbor protection. (Report at IV.E.6).
Adequate Protection for Secured Creditors
- “Foreclosure value,” should be used to determine adequate protection under Section 361, rather than the more commonly used valuation standards of liquidation value and going concern value. This concept is intended to capture the value of the secured creditor’s interest in collateral at the petition date. (Report at IV.B.1).
Plan Confirmation and Distributions
- The absolute priority rule should be altered by providing a mechanism for an immediately junior, otherwise out of the money class of creditors to receive distributions under a plan and from 363x sales based on the possibility that the value of the reorganized entity may appreciate after the plan effective date or entry of the 363x sale order. (Report at VI.C.1).
- A debtor should be permitted to cram down a Chapter 11 Plan without an accepting impaired class of claims to limit “gamesmanship” and the “manipulative, strategic, and tactical maneuvering by the debtor and creditors.” (Report at VI.F.1).
- Creation of the terms “reorganization value” and “redemption option value” to allow the possibility for adjustment of distributions to stakeholders, especially junior creditors in a plan context or senior creditors in a 363x sale of all or substantially all of a debtor’s assets. (Report at VI.C.1).
- Any adjustment would be based on post-emergence or post-sale increases in enterprise value and must occur within a “reasonable time” after the plan effective date or entry of the 363x sale order. (Report at VI.C.1).
Intellectual Property
- Debtors should be able to assume intellectual property licenses. (Report at V.A.4).
- Debtors should be able to assign intellectual property licenses, though the licensor would have the right to object on the basis that the harm to the licensor outweighs the benefit to the debtor. (Report at V.A.4).
- Foreign patents and copyrights should be included in the definition of “intellectual property.” (Report at V.A.4).
- Trademarks should be included in the definition of “intellectual property” and Section 365(n) should in large part apply to trademark licenses. (Report at V.A.5).
Case Administration and Claims Evaluation
- Debtors should be required to prepare a “valuation information package” or “VIP” containing a set package of financial and business information such as projections and business plans. The VIP would be shared with parties in interest, including creditors who can demonstrate that they will use the information for a “proper purpose.” This package would also be in addition to the creditor, asset and liability information that is already required to be disclosed in lists, schedules and monthly operating reports. (Report at IV.A.6).
- The time to assume or reject commercial leases under Section 365(d)(4) should be extended from 210 days to one year. (Report at V.A.6).
- Clarifying the proper valuation under Section 502(b)(6) of a landlord’s rejection damages claim when a tenant institutes Chapter 11. (Report at V.A.6).
- The in pari delicto doctrine should not apply to claims brought against third parties under Section 541 by a chapter 11 trustee. (Report at V.H).
- The examiner concept (and ending the debate over whether the appointment of an examiner is or is not mandatory) should be replaced with one that allows for the discretionary appointment of a disinterested person as an “estate neutral,” to assist in the investigation and resolution of disputed matters. (Report at IV.A.3).
The Report’s Importance
To the extent Congress considers future revisions to Chapter 11, which is uncertain, the Report will provide a comprehensive starting point for those conversations. It is also possible that courts could take the Report into account in the meantime when considering issues addressed in the Report.
Two Cleary Gottlieb partners served on Advisory Committees to the Commission. The Report was a collaborative effort and should not be considered to reflect the views of those partners or the firm generally.
[1] The Report is accessible at the ABI website at http://commission.abi.org/ and is available for download.
The full and original memorandum was published by Cleary Gottlieb on December 15, 2014 and is available here.