United States: Restructuring & Insolvency

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This country-specific Q&A provides an overview of the legal framework and key issues surrounding restructuring and insolvency in United States.

This Q&A is part of the global guide to Restructuring & Insolvency.

For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/restructuring-insolvency/

  1. What forms of security can be granted over immovable and movable property? What formalities are required and what is the impact if such formalities are not complied with?

    A security interest may be granted over property in a variety of ways. Pursuant to Article 9 of the Uniform Commercial Code (the “UCC”) — a standardized law adopted in all 50 states that governs secured transactions with respect to personal property — a security interest may be granted via (a) a UCC filing and/or a UCC fixture filing, or (b) control or possession (including via “control” obtained through a control agreement). Additionally, a security interest pursuant to Article 8 of the UCC — which generally only applies to certain types of investment property such as securities — may be granted via control or possession. For example, if a limited liability company or partnership has elected into Article 8, a lender can only obtain a security interest in that entity’s stock via possession and endorsement and, if done properly, can obtain “protected purchaser” status and obtain the collateral free of adverse claims. Finally, security interests in real property are effectuated via a real estate deed of trust and/or mortgage filing at the state or local level.

    If a filer does not adhere to the UCC’s or the state law specific filing requirements—such as using the appropriate form, appropriately identifying the collateral subject to the security interest on the form, listing the debtor’s correct legal name and street address, and listing the creditor’s correct legal name and street address—the filing may be insufficient to provide required notice to interested parties and the security interest may not be enforceable.

    The following are examples of issues that may arise with respect to the formalities surrounding granting security interests.

    • A secured party can usually only get the benefit of the interest held by the grantee of the security interest; therefore, if the grantee doesn’t hold full and unencumbered title to the property either as a result of title issues (more common in real estate) or because the property is subject to purchase money or other liens, then the secured party faces issues on both valuation and collection/realization on collateral.
    • Procedural issues that may arise range from, among other things, the failure to pay proper filing fees/taxes or stamp taxes and thus not properly recording and perfecting the security interests; failure to file relevant record of security interest in proper jurisdiction; technical failures in the filing itself related to wrong names, commas, periods, and/or misspellings; inadvertent releases of security interests; failure to file proper security instrument; and/or failure to file security interest within the statutory period due to changes in name or jurisdiction, etc.
  2. What practical issues do secured creditors face in enforcing their security (e.g. timing issues, requirement for court involvement)?

    Prior to a debtor filing for bankruptcy, a secured creditor has a number of different paths to enforcing its security interest. Such rights and remedies are generally governed by state law, which have largely been made uniform pursuant to the adoption of the UCC . To enforce a security interest and obtain status as a secured creditor, such interest must first be properly perfected. If not properly perfected, a creditor merely has an unsecured claim against the debtor. Certain security interests are automatically perfected, otherwise, depending on the circumstances, perfection may be achieved by filing a financing statement, mortgage or the like, or possessing or controlling the collateral. Upon a default, unless otherwise provided for in a governing security agreement, a creditor may have the right under Article 9 of the UCC to enforce its security interest by enforcing a judgment on the secured debt, taking possession or control of the collateral, foreclosing on the collateral or disposing of the collateral. In each case, proper notification and judicial process provided for in the UCC must be followed, as applicable.

    Once a debtor has filed for bankruptcy, a secured creditor may not enforce its security interest absent bankruptcy court approval authorizing such action. Specifically, section 362 of the U.S. Bankruptcy Code provides that, among other things, upon commencement of a case, a creditor may not “create, perfect or enforce” any lien against property of the estate. The automatic stay therefore bars any action by a creditor to enforce a security interest or improve its position as a secured creditor unless there is an exception to the automatic stay under section 362(b) of the U.S. Bankruptcy Code, or until the stay is terminated or lifted, respectively, under section 362(c) or 362(d) of the U.S. Bankruptcy Code.

    There are generally four scenarios in which a creditor may seek relief from the bankruptcy court and file a motion to “lift” the automatic stay pursuant to section 362(d) of the U.S. Bankruptcy Code: (1) “for cause,” including lack of adequate protection; (2) the debtor does not have equity in such property and such property is not necessary to an effective reorganization; (3) single asset real estate cases in which certain conditions are not met by the debtors; and (4) where the bankruptcy filing was part of a fraudulent scheme. A motion to lift the automatic stay must be heard by the bankruptcy court within 30 to 60 days, unless otherwise agreed by the parties or extended by the bankruptcy court for good cause. Any action taken that violates the automatic stay is typically treated as ineffective, regardless of whether such party had notice of the bankruptcy proceeding, and, unless withdrawn, may subject the party to sanctions.

  3. What is the test for insolvency? Is there any obligation on directors or officers of the debtor to open insolvency procedures upon the debtor becoming distressed or insolvent? Are there any consequences for failure to do so?

    There are two solvency tests commonly employed: (a) the balance sheet test; and (b) the equity or cash flow test. Recent case law indicates that either test may demonstrate (in)solvency, although the issue is not free from doubt.

    Under the law of the State of Delaware, which is the leading jurisdiction for U.S. corporate law jurisprudence, a company is considered insolvent under the balance sheet test if: (a) the sum of its debts exceeds the aggregate value of its assets; and (b) there is no reasonable prospect that the business can be successfully continued in the face of that insolvency.

    The valuation of assets must be included at “fair market value.” Neither book value nor GAAP accounting principles are controlling. Courts have provided limited guidance on whether the balance sheet test is determined on a going concern or liquidation value basis. However, there appears to be general support for either an individual asset valuation or a business enterprise valuation. Certain decisions have placed weight on the market’s perception of value, by reference to the trading price of a company’s securities and ability to raise debt or equity financing. While all liabilities must be included in the balance sheet test analysis, regardless of whether or not they are matured, contingent or unliquidated, it may be possible under certain circumstances to discount the present value of certain contingent liabilities.

    A company is considered insolvent under the equity or cash flow test if it is unable to pay its obligations as and when they come due. The key consideration is whether the company has the ability to produce sufficient cash to pay its debts as they mature. The source of cash may be from continuing operations, the disposition of assets, or other reasonably achievable capital raising activities. The caselaw is unclear as to how far in the future—or under how many different contingencies—a company’s ability to pay its debts must be assessed. Just because a company may be engaging in reasonable, ordinary course liquidity management (for example, by timing certain payables and receipts to “smooth out” cash flows and cash balances, as distinct from the inability to make any payables whatsoever) does not necessarily put the company in the zone of insolvency.

    The United States—unlike Germany and certain jurisdictions in Europe and elsewhere—does not obligate a debtor to commence insolvency proceedings if the debtor becomes insolvent or believes that it may be insolvent. Furthermore, while many, if not all, debtors in the United States are insolvent when they commence bankruptcy case, the U.S. Bankruptcy Code does not have an insolvency requirement.

    The import of solvency is key in a restructuring. Under the laws of the State of Delaware, where most U.S. corporations are formed, directors and officers generally owe their fiduciary duties to the company but not to creditors. While shareholders rely on directors and officers acting as fiduciaries to protect their interests, creditors are afforded protection through creditor rights (contracts, general commercial law, etc). Previously, Delaware cases implied that those fiduciary duties might shift to creditors when the company is insolvent, meaning that creditors may have the ability to sue officers and directors for breaches of fiduciary duties or for “deepening insolvency” when the company is insolvent or in the “zone of insolvency.” Recently, Delaware courts have partially clarified the law on this issue and limited the ability of creditors to bring direct actions against directors and officers.

  4. What insolvency procedures are available in the jurisdiction? Does management continue to operate the business and / or is the debtor subject to supervision? What roles do the court and other stakeholders play? How long does the process usually take to complete?

    The U.S. Bankruptcy Code is a federal statute that governs insolvency proceedings in the United States. The U.S. Bankruptcy Code is the preeminent method for restructuring distressed enterprises (both public and private) in the United States.

    Chapter 7: Liquidation (Individuals and Corporations). Individuals and corporations may file for chapter 7, which governs liquidations. Upon filing a chapter 7 petition, a corporate debtor’s management and board are displaced, and a trustee is appointed to marshal and liquidate the assets for the benefit of creditors. One of the trustee’s first actions is to file a notice to all creditors, including actual and known potential litigation claimants, alerting them of the chapter 7 filing. Thereafter, the chapter 7 trustee will convene a meeting of creditors, examine the debtor and its assets (including potential claims that it may have), liquidate the debtor’s property, and, ultimately, distribute the proceeds of estate property to holders of claims and interests that are entitled to a recovery. The length of time that it takes to complete a chapter 7 liquidation varies based on the facts and circumstances, and it may take several years based on the nature and scope of the assets of the debtor (such as claims against former employees, officers, directors, counterparties, creditors, and other parties, which claims often take a long period of time to resolve). The length of a chapter 7 liquidation depends on the facts and circumstances of a particular case; an individual with minimal assets and liabilities may receive a discharge in a matter of months; on the other hand, it is not uncommon for it to take years for a trustee to resolve complex causes of action, liquidate hard assets, and reconcile claims in chapter 7 cases of larger corporate debtors.

    Chapter 9: Municipalities. Chapter 9 of the U.S. Bankruptcy Code permits certain political subdivisions of states to reorganize like a corporation under chapter 11 of the U.S. Bankruptcy Code (which is described in greater detail below). To file for chapter 9, a municipality (only municipalities, not states or the federal government may file for chapter 9) must be: (a) be authorized to seek protection under state law; (b) be insolvent; (c) have a desire to effect a plan to adjust its debts; (d) have: (i) agreed on a plan with a majority of claims in each class; (ii) negotiated in good faith and failed to obtain such a majority in each class; (e) demonstrated that negotiations are impracticable; or (f) reasonably believed that a creditor may try to obtain an avoidable transfer. Upon filing, the automatic stay protects the municipality from enforcement actions. However, the protections of the automatic stay are substantially broader for a chapter 9 debtor than they are for a chapter 11 debtor. In addition to the stay under section 362, among other things, section 922 applies to actions or proceedings against officers or inhabitants of the municipality, a system that ensures that creditors cannot gain leverage over municipalities by applying pressure to its officials or its residents. The end result of a chapter 9 case is confirmation of a plan of arrangement, which is similar (but not identical) to a plan of reorganization in a chapter 11 case. A bankruptcy court shall confirm a plan if and only if the plan complies with certain chapter 11 confirmation requirements, including, that it has been proposed in good faith and not by any means forbidden by law and does not discriminate unfairly and is fair and equitable; the plan complies with the provisions of chapter 9; the debtor is not legally prohibited from taking any action necessary to carry out plan; and the plan is in the best interests of creditors and is feasible. A notable distinction between a chapter 9 confirmation hearing and one in chapter 11 is that the absolute priority rule has limited application in chapter 9 because there are no shareholders. And, because a municipal debtor cannot liquidate, the best interests test considers whether the plan is a better alternative to creditors than dismissal of the case. Additionally, the bankruptcy court has a much more limited role in reviewing operational issues than it does in a corporate setting such as chapter 11, which is described in further detail below.

    Chapter 11: Reorganization (Individuals and Corporations). Chapter 11 of the U.S. Bankruptcy Code governs reorganizations. An individual or a corporate entity is entitled to file for chapter 11. A chapter 11 restructuring is a court-supervised restructuring of a debtor’s business and pre-filing financial obligations. Chapter 11 is focused on reorganization, not liquidation; instead, the debtor generally continues ordinary course business and seeks to emerge with a stronger balance sheet and, where necessary, operational changes enabled by the U.S. Bankruptcy Code, as well. The goal of a chapter 11 restructuring is confirmation of a “plan of reorganization,” which is a court-approved contract that replaces the debtor’s pre-filing obligations with a new set of manageable obligations. During the post-filing period, a corporate debtor’s board and management typically remain in control absent the infrequent appointment of a trustee by the court (either because it is in the best interests of creditors or “for cause,” such as fraud, dishonesty, incompetence, or gross mismanagement. While the debtor’s prepetition management typically stays in control, any action outside of the ordinary course of business is subject to notice to creditors and approval by the court. The length of a chapter 11 restructuring varies based on the complexity of the debtor’s affairs. Upon filing a bankruptcy petition, the debtor has the exclusive right to propose a chapter 11 plan for 120 days and to solicit acceptances of that plan for 180 days. Thereafter, the court may extend the debtor’s exclusive period to file a plan for up to 18 months post-filing and the debtor’s exclusive right to solicit acceptances of the plan for up to 20 months post filing.

    Chapter 12: Family Fishermen and Farmers. Chapter 12 is designed for “family farmers” or “family fishermen” with “regular annual income.” Under chapter 12, a debtor proposes a repayment plan to make installments to creditors over three to five years. Generally, the plan must provide for payments over three years unless the court approves a longer period “for cause.” In tailoring bankruptcy law to meet the economic realities of family farming and the family fisherman, chapter 12 eliminates many of the barriers a debtor would face if seeking to reorganize under either chapter 11 or 13 of the U.S. Bankruptcy Code. For example, chapter 12 is more streamlined, less complicated, and less expensive than chapter 11, which is better suited to large corporate reorganizations. In addition, few family farmers or fishermen find chapter 13 to be advantageous because it is designed for wage earners who have smaller debts than those facing family farmers. In chapter 12, the U.S. congress sought to combine the features of the U.S. Bankruptcy Code, which can provide a framework for successful family farmer and fisherman reorganizations.

    Chapter 13: Individuals. A chapter 13 bankruptcy is also called a wage earner’s plan. It enables individuals with regular income to develop a plan to repay all or part of their debts. Under this chapter, a debtor proposes a repayment plan to make installments to creditors over three to five years. If the debtor’s current monthly income is less than the applicable state median, the plan will be for three years unless the court approves a longer period “for cause.” If the debtor’s current monthly income is greater than the applicable state median, the plan generally must be for five years. In no case may a plan provide for payments over a period longer than five years. During this time the law forbids creditors from starting or continuing collection efforts. This chapter discusses six aspects of a chapter 13 proceeding: the advantages of choosing chapter 13, the chapter 13 eligibility requirements, how a chapter 13 proceeding and plan works, and the special chapter 13 discharge.

    Chapter 15: Recognition of Foreign Proceedings. The U.S. has largely adopted the principles of the United Nations Commission on International Trade Law (“UNCITRAL”) Model Law on Cross-Border Insolvency, and enacted a set of procedures for cooperation among U.S. and foreign courts presiding over multiple insolvency proceedings. These procedures, enacted in 2005, are embodied in chapter 15 of the U.S. Bankruptcy Code. Although courts utilized ad hoc protocols and other contractual procedures prior to chapter 15’s enactment, cross-border proceedings now benefit from express statutory authority regarding international recognition of judgments. Chapter 15 is essentially designed to give U.S. judicial access to a foreign debtor (or representative thereof) for the purpose of protecting the foreign debtor’s U.S. assets and providing express statutory authority for the foreign debtor or its representative to administer the foreign debtor’s U.S. assets.

    As discussed in more detail below, foreign proceedings can be recognized in the U.S. either as “foreign main proceedings” or “foreign non-main proceedings.” Recognition as a “foreign main proceeding” provides for immediate application of the U.S. Bankruptcy Code’s automatic stay to the foreign debtor’s U.S. assets. Although recognition as a “foreign non-main proceeding” does not, a foreign debtor or its representative can petition the court to impose the automatic stay. Recognition as a “foreign main proceeding” requires demonstration that the foreign debtor’s main insolvency proceeding constitutes an actual “foreign proceeding” as defined in the U.S. Bankruptcy Code and the foreign debtor’s “center of main interests” (“COMI”) is located in the foreign jurisdiction.

    Once a foreign proceeding is formally “recognized” under chapter 15, its judgments generally will be enforced unless the parties in interest opposing recognition demonstrate that recognition is “manifestly contrary to the public policy of the United States,” a very demanding standard. Upon recognition: (a) foreign representative has standing and can intervene in U.S. courts; (b) U.S. courts shall grant “comity or cooperation” to foreign representative; and (c) the foreign representative can file involuntary or voluntary bankruptcy petitions. For a foreign main proceeding, U.S. Bankruptcy Code sections 361 and 362 regarding adequate protection and automatic stay automatically apply. For non-main proceedings, representative needs to apply for automatic stay. In addition, the foreign representative can operate business as debtor-in-possession, can sell U.S. assets, and avoid postpetition transfers, with court approval required for activities outside the ordinary course of business. For foreign main and non-main proceedings, court can: (a) grant additional relief requested by representative, including injunctions; (b) allow discovery relating to debtor’s assets and affairs; (c) entrust distribution of U.S. assets to foreign representative, but only if interests of U.S. creditors are protected; and (d) stay execution or right to transfer assets.

  5. How do creditors and other stakeholders rank on an insolvency of a debtor? Do any stakeholders enjoy particular priority (e.g. employees, pension liabilities)? Could the claims of any class of creditor be subordinated (e.g. equitable subordination)?

    The U.S. Bankruptcy Code provides for an absolute priority scheme by which creditors are paid before shareholders in accordance with their respective priorities under applicable law. Similarly situated creditors are grouped together and entitled to their pro rata distribution of a debtor’s property depending on the size of each creditor’s claim. As a general matter, secured creditors with blanket liens are entitled to a recovery before unsecured creditors, and unsecured creditors are entitled to a recovery before shareholders. However, certain provisions of the U.S. Bankruptcy Code provide for special protections for certain creditors. For example, section 1110 of the U.S. Bankruptcy Code allows aircraft financiers to repossess their collateral without the need to lift the automatic stay if the debtor does not agree to perform all of its obligations before 60 days from the bankruptcy filing date. Additionally, various safe harbor provisions in the U.S. Bankruptcy Code (i.e., sections 555, 556, and 559 through 562 of the U.S. Bankruptcy Code) protect derivative contract counterparties, allowing them to exercise setoff rights and liquidate or terminate such contracts postpetition without the need to lift the automatic stay.

    Certain stakeholders that would otherwise only be entitled to a general unsecured claim are entitled to priority payment pursuant to section 507(a) of the U.S. Bankruptcy Code. Included in these priorities are claims related to (a) administrative expenses that fall under section 503(b) of the U.S. Bankruptcy Code, which sets forth expenses that are required to administer the bankruptcy case itself, (b) employee wages earned in the 180 days prior to a bankruptcy filing (up to a statutorily imposed cap), (c) unpaid contributions to employee benefit plans during the 180 days prior to a bankruptcy filing, and (d) certain prepetition taxes. Additionally, the U.S. Bankruptcy Code provides for certain “superpriority” claims that come before payment of other priority claims set forth in 507(a), such as claims on account of postpetition financing or claims for failure to provide adequate protection.

    A debtor must also satisfy a number of statutorily imposed requirements before it may reject a collective bargaining agreement with one of its unions or avoid payment of retiree and pension benefits. In particular, sections 1113 and 1114 of the U.S. Bankruptcy Code generally provide, among other things, that before modifying or rejecting any collective bargaining agreement or modifying or terminating any retiree obligations, a debtor must demonstrate that it has made a proposal to the affected union representative or retiree committee, that the union representative or retiree committee has refused to accept the modifications without good cause, and that the balance of the equities favors such modifications.

    A bankruptcy court may, in limited circumstances subordinate one otherwise pari passu claim to another or recharacterize a debt claim as equity. Equitable subordination is statutorily provided for in section 510(c) of the U.S. Bankruptcy Code and is meant to remedy inequitable conduct by one party that results in injury to other creditors. In determining whether inequitable conduct should result in equitable subordination of a creditors claim courts will look to whether: (a) the claimant engaged in some type of inequitable conduct; (b) the misconduct resulted in injury to other creditors or conferred an unfair advantage on the claimant; and (c) equitable subordination would be inconsistent with the provisions of the U.S. Bankruptcy Code. Recharacterization on the other hand allows a bankruptcy court to recharacterize a debt claim as equity when the circumstances indicate that the debt transaction was actually an equity contribution. The factors that a bankruptcy court considers in deciding whether to recharacterize alleged debt as equity are as follows: (1) names given to instruments, if any, evidencing alleged indebtedness; (2) presence or absence of fixed maturity date and schedule of payments; (3) presence or absence of fixed rate of interest and interest payments; (4) source of repayments; (5) adequacy or inadequacy of debtor’s capitalization; (6) identity of interest between creditor and stockholder; (7) security, if any, for advances; (8) corporate debtor’s ability to obtain financing from outside lending institutions; (9) extent to which advances were subordinated to claims of outside creditors; (10) extent to which advances were used to acquire capital assets; and (11) presence or absence of sinking fund to provide repayments.

  6. Can a debtor’s pre-insolvency transactions be challenged? If so, by whom, when and on what grounds? What is the effect of a successful challenge and how are the rights of third parties impacted?

    Under the U.S. Bankruptcy Code, a debtor may: (a) avoid a voluntary security interest that, at the time the petition is filed, is not properly perfected; (b) avoid the fixing of certain statutory liens; (c) avoid fraudulent transfers; (d) avoid unauthorized postpetition transfers of property; or (e) recover prepetition preferential transfers. The U.S. Bankruptcy Code requires a debtor to pursue any avoidance action within two years of the bankruptcy filing; the relevant “look back” period with respect to any particular action varies based on the nature of the action.

    Fraudulent Transfers
    A debtor may “avoid” transactions as constructively or actually fraudulent. If successful, the pre-transaction status quo is restored by either unwinding the transaction or entitling the prevailing party to money damages. The debtor may avoid certain transfers of property (or incurrence of debt) made within two to six years before the petition date.

    A transfer is actually fraudulent if it was made the transfer “with actual intent to hinder, delay or defraud any creditor.”

    A transfer is treated as a constructive fraudulent (i.e., treated as fraudulent because of its effect on other similarly situated creditors, as opposed to the debtor’s intention) if the debtor received less than equivalent value in exchange for such transfer, and (a) the debtor was insolvent when the transfer was made or became insolvent as a result; (b) the debtor was left with unreasonably small capital; or (c) the debtor intended to incur, or believed that the debtor would incur, debts beyond the debtor’s ability to pay as such debts matured.

    While proving constructive fraud is based on objective criteria, actual fraud involves the state of the debtor’s mind. Direct evidence of the debtor’s state of mind is seldom available, must be shown by circumstantial evidence and inferred from observable conduct. Courts have identified typical patterns of behavior that create suspicion of fraud, known as “Badges of Fraud.”

    Preferences
    In addition to fraudulent transfers, a debtor may avoid preferential transfer, which is defined as: (a) a transfer of an interest of the debtor in property; (b) to or for the benefit of a creditor; (c) for or on account of an antecedent debt; (d) made while the debtor was insolvent (presumption of insolvency within 90 days of bankruptcy filing); (e) made on or within 90 days of bankruptcy filing (or within 1 year for transfers to insiders); and (f) that enables the creditor to receive more than it would in a hypothetical chapter 7 liquidation. Like fraudulent transfers, a preference action, if successful, will unwind the challenged transaction or the court will award the plaintiff with a claim for money damages.

    Even if a debtor proves the prima facie case for a preference, the U.S. Bankruptcy Code includes certain defenses to preferences actions. The purpose of the exceptions is to encourage creditors to continue to deal with troubled debtors without fear that they will have to disgorge payments received for value give. Typical defenses include: (a) the debtor receives contemporaneous exchange for new value from a creditor (e.g., check tendered for delivery of goods, cash on demand transactions; (b) the debtor receives contemporaneous new value from a party other than the creditor; and/or (c) recurring, customary credit transactions that are incurred and paid in the ordinary course of business of the debtor and the debtor’s transferee.

    While it may be easy to spot a preferential transfer, that does not always mean that the debtor will avoid it. In a large case, there can be thousands of preference actions. Most will typically be resolved without need for a trial. Debtors sometimes forego preference campaigns to maintain go-forward relationships with trade partners/customers. Any transferee from whom a debtor recovers a preferential payment is entitled to an unsecured claim equal to the amount of the recovered payment.

    Strong-Arm Powers
    Section 544 of the U.S. Bankruptcy Code provides additional avoidance powers to the estate. Section 544(a) of the U.S. Bankruptcy Code provides that a debtor shall have, as of the commencement of the case, and without regard to any knowledge of the debtor or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by lien creditors under applicable non-bankruptcy law (which typically provides that an unperfected security interest is subordinate to the rights of a lien creditor and that a lien creditor may avoid any such unperfected security interest).

    Section 544(b) goes a step further by providing that a debtor may avoid a transfer that is “voidable by a creditor” under applicable state law (which often means the Uniform Fraudulent Transfer Act, which has been enacted in more than 40 states). For a debtor to bring a fraudulent transfer cause of action under section 544(b) based on state law, the debtor must first prove the existence of an actual unsecured creditor who (a) holds an allowable claim on the date the bankruptcy petition was filed and (b) has the ability and power to void a transfer or obligation of the debtor as either constructively or actually fraudulent under the applicable state fraudulent transfer law. If the debtor fails to prove the existence of a triggering creditor, the debtor is prohibited from pursuing a section 544(b) actual or constructive fraud claim under applicable state law, regardless of the potential merits of the claim. If the debtor does prove the existence of such a triggering creditor, it then can step into that creditor’s shoes to bring and prosecute the fraudulent transfer action under applicable state law.

    The U.S. Bankruptcy Code permits the debtor to use the single triggering creditor’s standing and cause of action under applicable law to avoid the entire transaction or obligation for the benefit of all creditors. This is a particularly powerful tool: in recent cases, debtors and other creditors have asserted that this provision permits the debtor to step into the shoes of the IRS—which typically is an unsecured creditor in every bankruptcy case and benefits from a 10-year lookback period (rather than 2 years, provided by the U.S. Bankruptcy Code, or four to six years, as provided by state law)—to pursue avoidance actions.

    Statutory Liens
    The U.S. Bankruptcy Code also allows debtor to avoid certain statutory liens. The first type are liens that first become effective against the debtor due to the debtor’s financial distress (so-called “springing liens”), e.g., liens that become effective upon: (a) the commencement of a case concerning the debtor under the U.S. Bankruptcy Code or the commencement of an insolvency proceeding concerning the debtor other than under title 11; (b) the appointment of a custodian or a custodian being authorized to take or takes possession of the debtor’s property; (c) the insolvency of the debtor; (d) the debtor’s financial condition failing to meet a specified standard; and (e) the execution against the debtor’s property at the insistence of an entity other than the statutory lien holder.

    The second type of avoidable liens are those which would not be perfected or enforceable at the commencement of the case against a hypothetical bona fide purchaser who purchases the property at the commencement of the case. Enforceability of a statutory lien depends upon the status of its perfection under nonbankruptcy law at the time of the filing of the bankruptcy case. Where the applicable nonbankruptcy law permits a statutory lien to defeat the rights of a bona fide purchaser, the lien is valid against a trustee. The trustee will prevail where nonbankruptcy law specifically or by implication prohibits enforcement of a statutory lien against a bona fide purchaser. Note, however, certain statutory amendments basically render it impossible to avoid tax liens.

    Rights of Third Parties and Standing
    While avoidance actions are property of the bankruptcy estate that the debtor may pursue, bankruptcy courts may grant standing to other parties (such as an official committee of unsecured creditors) to pursue such actions, in which case a third party may step into the shoes of the debtor. To obtain standing, a creditor must file a motion with the bankruptcy court and demonstrate that: (a) a colorable claim exists; (b) the creditor has made a demand upon the debtor to pursue a claim; (c) the debtor has refused to pursue the claim; and (d) it is in the best interests of the debtor’s creditors for the creditor seeking standing to pursue the claim, i.e., the projected recovery on the claim will exceed the potential costs associated with pursuing the claim.

  7. What restructuring and rescue procedures are available in the jurisdiction, what are the entry requirements and how is a restructuring plan approved and implemented? Does management continue to operate the business and/or is the debtor subject to supervision? What roles do the court and other stakeholders play?

    A company seeking to restructure its assets will generally seek protection under chapter 11 of the U.S. Bankruptcy Code. Chapter 11 is a court supervised process used to implement the restructuring of a company’s business and financial obligations. There is no eligibility requirement for commencing a chapter 11 case and a company need not be insolvent to seek chapter 11 protection. A debtor typically will commence a chapter 11 case by filing a voluntary petition for relief in the bankruptcy court. The U.S. Bankruptcy Code also provides a mechanism for creditors to file involuntary petitions against debtors under certain circumstances, such as failure to generally pay debts as they come due. Upon filing, the debtor will become a debtor in possession and a bankruptcy “estate” consisting of all of the debtor’s property will be created. In the majority of cases, management and the board of directors stay in control of the debtor’s operations. In rare cases where fraud or misconduct is alleged, the bankruptcy court may appoint a trustee to oversee the debtor’s operations and administer the chapter 11 proceedings.

    The ultimate goal of a chapter 11 case is to confirm a plan of reorganization. The plan establishes the key terms of the debtor’s restructuring and the treatment of all classes of creditors and equity holders. The U.S. Bankruptcy Code provides a debtor with a 120-day “exclusive period” from the petition date to file a plan, plus an additional 60 days to solicit votes for the plan. This period may be extended for cause to a date that is no more than 18 months from the petition date. Once the exclusive period lapses, any party may propose a plan. Before soliciting votes on a plan, a debtor must first obtain bankruptcy court approval of a disclosure statement, which provides the necessary information for a reasonable investor to make an informed judgment about whether to vote for the plan. Once a disclosure statement is approved, impaired classes of creditors may vote to accept or reject the plan. For a class of claims to approve the plan, at least 2/3 in dollar amount and more than 1/2 in number of voting creditors must vote in favor of the plan. After voting, the court will confirm a plan if, among other things, the plan complies with the applicable provisions of the U.S. Bankruptcy Code and has been proposed in good faith. Once the plan is confirmed, the debtor exits chapter 11 on the effective date. On the effective date, the debtor’s assets vest in the reorganized company free and clear of all claims and the reorganized debtor is discharged from all prepetition debts.

    The bankruptcy court plays a critical role in a chapter 11 case, overseeing and approving all non-ordinary course transactions and ultimately determining whether to approve a debtor’s plan of reorganization. Additional key stakeholders include secured creditors, unsecured creditors (including the official committee of unsecured creditors), shareholders, the board of directors, management, and the office of the United States Trustee.

  8. Can a debtor in restructuring proceedings obtain new financing and are any special priorities afforded to such financing (if available)?

    A debtor generally has three sources for operating capital during a reorganization: (a) existing cash or future cash flows not subject to a secured creditor’s security interest; (b) existing cash and cash generated from continued operations that is subject to a creditor’s perfected prepetition secured interest; and (c) postpetition financing when cash on hand is not available or is insufficient to cover projected needs.

    Where cash on hand may not be sufficient to operate a debtor’s business in chapter 11, the U.S. Bankruptcy Code also permits a debtor to obtain DIP financing and provides incentives for lenders to extend credit. DIP financing is often required because prepetition facilities such as asset-based revolving loans or securitization facilities are frozen under U.S. bankruptcy law as of the filing and may not be drawn upon. DIP facilities are generally similar to out-of-court credit facilities with respect to representations, warranties, covenants, defaults, and credit documentation.

    DIP financing typically comes from one of several potential sources: (a) existing secured lenders; (b) junior creditors; (c) equity holders; (d) commercial banks or hedge funds; and (e) prospective buyers.

    Section 364 of the U.S. Bankruptcy Code governs access to postpetition credit. Section 364(a) of the U.S. Bankruptcy Code authorizes the debtor to obtain unsecured credit and to incur unsecured debt in the ordinary course of business (i.e., to support its day-to-day operations related to its business). Such obligations will receive administrative expense status under section 503(b)(1) of the U.S. Bankruptcy Code.

    If the debtor seeks to obtain credit outside of the ordinary course of business, the debtor must seek and obtain court authorization pursuant to section 364(b) of the U.S. Bankruptcy Code. If approved by the bankruptcy court, such claims will receive administrative expense status under section 503(b)(1).

    If the debtor is unable to find a lender willing to provide such credit in exchange for “ordinary” administrative expense status, the debtor may seek authorization for alternative financing under section 364(c) and/or section 364(d)(1) of the U.S. Bankruptcy Code. More specifically, section 364(c) provides that a debtor may seek credit that will receive “superpriority” administrative expense status, a lien on unencumbered property, or a junior lien on property that is already subject to a lien.

    In the event that the debtor is unable to obtain credit otherwise, the debtor may also seek to obtain credit by providing a senior or pari passu lien on property that is already subject to a lien pursuant to section 364(d)(1) of the U.S. Bankruptcy Code (often referred to as a “priming” DIP).

    To obtain DIP financing, a debtor must provide “adequate protection” to any creditor with an existing lien on the collateral being pledged. Adequate protection is intended to compensate a creditor for the diminution in the value of its collateral because of: (a) the imposition of the automatic stay and the corresponding limitation on the creditor’s ability to foreclose on its collateral; (b) the debtor’s use of the property (e.g., depreciation); and (c) the grant of a pari passu or priming lien under a DIP facility. More specifically, section 361 of the U.S. Bankruptcy Code provides a non-exclusive list of what may constitute adequate protection: periodic cash payments; additional/replacement liens; or the “indubitable equivalent” of the creditor’s interest in the collateral.

    A “primed” lender may also obtain a superpriority “administrative” claim under section 507(b) of the U.S. Bankruptcy Code if adequate protection is insufficient to cover diminution. Administrative claims must be paid in full in cash upon confirmation of a chapter 11 plan of reorganization.

  9. How are existing contracts treated in restructuring and insolvency processes? Are the parties obliged to continue to perform their obligations? Will termination, retention of title and set-off provisions in these contracts remain enforceable? Is there any an ability for either party to disclaim the contract?

    Pursuant to section 365 of the U.S. Bankruptcy Code, a debtor has the unilateral right to assume (i.e., continue) or reject (i.e., terminate) executory contracts, subject only to a highly deferential business judgment test. An executory contract is a contract with material obligations remaining unperformed by both parties. A debtor typically has until confirmation of a plan to decide whether to assume or reject executory contracts. Both parties must continue to perform under the contract until such contract is assumed or rejected, regardless of if the debtor has not paid outstanding prepetition amounts. If the contract terminates postpetition pursuant to its own terms, neither party is obligated to continue performance under such contract, however, a creditor may have an administrative claim for any postpetition defaults. If the debtor chooses to assume a contract, then the debtor must cure any pre or postpetition defaults and is bound by the contract going forward. If the debtor choses to reject a contract, then the debtor is no longer bound by the contract and the counterparty is entitled to file a claim for any damages arising from such rejection.

    A debtor must assume or reject the entire contract and cannot seek to disclaim only certain portions of the contract. Therefore, as a general matter, any provisions that existed in the contract prior to assumption or rejection remain enforceable. One exception, however, is the existence of so-called “ipso facto” termination provisions, which provide that a contract will terminate upon bankruptcy. Section 365(e)(1) of the U.S. Bankruptcy Code specifically states that, except in very limited circumstances, such provisions are unenforceable. Additionally, while setoff rights are generally preserved under section 553 of the U.S. Bankruptcy Code, a creditor is precluded from exercising such setoff rights without bankruptcy court approval.

  10. What conditions apply to the sale of assets/the entire business in a restructuring or insolvency process? Does the purchaser acquire the assets “free and clear” of claims and liabilities? Can security be released without creditor consent? Is credit bidding permitted?

    In bankruptcy cases, debtors have the option of selling some or all of their assets under section 363 of the U.S. Bankruptcy Code. Assets sold in the ordinary course of business do not require court approval, while assets sold outside of the ordinary course of business require notice, a hearing, and court approval. Alternatively, debtors can sell their assets pursuant to a plan of reorganization. When selling assets outside of the ordinary course business under section 363(b) of the U.S. Bankruptcy Code, a debtor need only show that there is a good business reason for the sale of some or all of its assets. Some jurisdictions more closely scrutinize a sale of all of the debtor’s assets for the purposes of avoiding a sub rosa plan.

    One benefit of selling assets under section 363 of the U.S. Bankruptcy Code is that property can generally be transferred to a buyer “free and clear” of all liens and encumbrances. Under section 363(f), a debtor can sell assets free and clear of any interest if: (a) nonbankruptcy law permits; (b) such entity consents; (c) a lienholder of the property is oversecured; (d) such interest is the subject of a bona fide dispute; or (e) the interest holder can be compelled to accept a money satisfaction. There may, however, be exceptions to this “free and clear” rule, such as environmental claims, product liability claims, employee claims, and certain governmental claims.

    The U.S. Bankruptcy Code also allows a holder of a lien securing an allowed claim to “credit bid” its interest, i.e., use an offset of any secured claims as purchasing consideration instead of cash. Generally, a secured creditor is allowed to credit bid the face amount of its secured claim. It is common for secured creditors to seek to “credit bid” acquired debt to purchase assets both in- and out-of-bankruptcy. “Loan to own” investors may typically purchase debt for the specific purpose of seeking to credit bid at a bankruptcy auction. More recently, however, some courts have found “cause” to limit credit bids to foster a competitive bidding environment. In addition, a secured creditor’s right to credit can also be waived if that creditor fails to timely assert its right.

  11. What duties and liabilities should directors and officers be mindful of when managing a distressed debtor? What are the consequences of breach of duty?

    Fiduciary duties of directors and officers are typically governed by the state’s law where the entity is formed or incorporated. These duties include the duty of care and the duty of loyalty. The duty of care requires that directors and officers be informed and exercise the care of a prudent person under similar circumstances. This duty is slightly mechanical in nature and requires fiduciaries to establish and follow a decision-making process and maintain good records. The duty of loyalty requires directors and officers to act in good faith and in a manner they reasonably believe to be in the best interests of the company. This duty prohibits fiduciaries from engaging in bad faith or self-dealing, or making decisions that would be a conflict of interest with the company.

    In analyzing duty of care and loyalty, the business judgment rule generally applies, which creates a presumption that the directors and officers acted on an informed basis, in good faith, and with the honest belief that the action was in the best interests of the company and its shareholders. The business judgment rule applies regardless of whether a company is solvent or insolvent. As a practical matter, however, a heightened level of scrutiny based on hindsight may be applied to directors and officers of an insolvent or near-insolvent company.

    A number of cases in the United States have addressed to what extent directors may be sued for failure to maintain proper oversight over a corporation. Many cases in the Delaware courts have generally, though not exclusively, been favorable to directors. Because a breach of the duty of due care is difficult to prove, and because a corporation may exculpate a director from paying money damages for breaching the duty of due care, plaintiffs have generally asserted claims based on a failure to act in good faith. Directors, on the other hand, defend many of these cases for failure to act in good faith or lack of oversight with the business judgment rule. Directors and officers of solvent companies generally owe fiduciary duties to shareholders. Delaware cases have previously indicated that these fiduciary duties may shift to to creditors when a company is insolvent. Recently, however, Delaware courts have partially clarified the law and limited the ability of creditors to sue directors and officers.

    Once a company files for bankruptcy, however, there is additional oversight over a company’s affairs, even though the board of directors is typically still making decisions in the best interest of all stakeholders. The United States Trustee, an official of the United States Department of Justice, performs a variety of administrative functions, as well as oversight. Bankruptcy courts often heavily rely on the advice of the United States Trustee and although the United States Trustee does not make decisions for the board, it can inquire about, or object to, a decision made by the company through its board.

  12. Is there any scope for other parties (e.g. director, partner, parent entity, lender) to incur liability for the debts of an insolvent debtor?

    Generally, directors, partners and shareholders, including parent companies, will not be held liable for the liabilities of a corporation unless a court disregards the corporate form under the doctrine of “piercing the corporate veil.” Despite different formulations, courts generally analyze two considerations in determining whether the corporate veil should be pierced: (a) whether there was a fraud or injustice perpetuated in the use of the corporate form and (b) whether the corporation has been so dominated by an individual or corporate parent that the subsidiary is relegated to the status of a mere shell, instrumentality or alter ego. With respect to whether a corporation is a mere shell, instrumentality or alter ego, courts will generally look to the following factors: (a) failure to observe corporate formalities; (b) undercapitalization; (c) intermingling of corporate funds; (d) overlap in corporate officers, directors and personnel; (e) common office space, address and telephone numbers; (f) the amount of business discretion exercised by the subsidiary corporation; (g) whether the two companies deal with each other at arm’s length; (h) whether the corporations exist as independent sources of profit; (i) the guarantee of the subsidiary’s debts by the parent; and/or (j) common use of corporate property. These factors are not exhaustive, and the presence of one or more factors does not mandate veil piercing.

    Directors may be held liable under federal and state laws for failure to ensure payment of certain trust fund taxes, such as payroll taxes. In particular, a corporation is required to remit any withheld taxes from an employee’s paycheck directly to the government. Misuse of these funds or failure to remit can lead to personal liability for any person responsible for such misuse or failure to remit.

    Typically, no fiduciary duty arises out of the contractual arms’ length debtor-creditor relationship. However, there are still a number of theories by which a lender could be found liable for damages to the debtor, have its debt claims equitably subordinated or recharacterized or have its claims avoided. These scenarios usually arise when a lender exerts excessive control over a debtor’s finances and operations. A lender is said to exercise dominion and control when it exerts sufficient authority over the debtor so as to dictate corporate policy and the disposition of assets.

  13. Do restructuring or insolvency proceedings have the effect of releasing directors and other stakeholders from liability for previous actions and decisions?

    Section 1123 of the U.S. Bankruptcy Code serves as the basis by which a debtor can seek to obtain various forms of releases in a plan of reorganization from certain types of potential prepetition claims and causes of action. Specifically, section 1123 of the U.S. Bankruptcy Code provides that a plan of reorganization may “provide for the settlement or adjustment of any claim or interest belonging to the debtor or to the estate” and may “include any other appropriate provision not inconsistent” with the U.S. Bankruptcy Code. There are generally two types of plan releases: (a) a debtor release and (b) a third-party release (i.e., a release by a debtor’s creditors), which may be consensual or non-consensual. Debtor releases, consensual third-party releases and non-consensual third-party releases are subject to different legal standards for approval.

    Releases from liability provided by debtors to non-insider, non-debtors are subject to the business judgment standard. However, a proposed release of claims held by a debtor against an “insider” of that debtor (i.e., an officer or director) may be subject to a higher level of scrutiny, referred to as the “entire fairness standard,” which examines whether the settlement is procedurally and substantively fair.

    Consensual third-party releases — releases that require the affirmative agreement of the creditor affected — are generally permitted. However, there is some disagreement among courts as to when a release is consensual. Some courts construe consent narrowly, requiring a party to affirmatively vote in favor of a plan and forgo opting out of — or electing to opt into —the release to demonstrate consent. Other courts, however, have found that parties that fail to vote on or object to a plan or are unimpaired by a plan are deemed to have consented to any such third-party release.

    Non-consensual third-party releases may be permissible, but are only granted in extraordinary cases, and may be unavailable altogether in certain jurisdictions. In determining whether a non-consensual third-party release is permissible, courts will generally look to whether such releases are fair, necessary to the reorganization and supported by specific factual findings.

  14. Will a local court recognise concurrent foreign restructuring or insolvency proceedings over a local debtor? What is the process and test for achieving such recognition?

    A U.S. bankruptcy court will recognize a pending foreign proceeding upon a chapter 15 filing under section 1515 of the U.S. Bankruptcy Code and after the court conducts an analysis under section 1517 of the U.S. Bankruptcy Code. A chapter 15 proceeding is always accompanied by another proceeding to which the chapter 15 filing is ancillary. In order to qualify for recognition, the foreign proceeding must meet 7 requirements:

    • (1) it must be a proceeding; (2) that is either judicial or administrative in character; (3) that is collective in nature; (4) that is being conducted in [a] foreign country; (5) that is authorized or conducted under law relating to insolvency or adjustment of debts; (6) in which debtor’s assets and affairs are subject to control or supervision of foreign court; and (7) which is for purpose of reorganization or liquidation.

    In granting recognition the court must determine whether the foreign insolvency proceeding will be recognized as a foreign main proceeding or a foreign non-main proceeding. If a foreign proceeding is pending in a country where the debtor’s center of main interest is located, the bankruptcy court is statutorily obligated to issue an order recognizing the proceeding as a foreign main proceeding under section 1517(b)(2) of the U.S. Bankruptcy Code. Under section 1502(4) of the U.S. Bankruptcy Code, a debtor may not have more than one center of main interest, and the location of the debtor’s center of main interests is an objective determination based on the viewpoint of third parties, usually creditors. The ultimate burden of proof for establishing the debtor’s center of main interest under a chapter 15 recognition proceeding lies with the petitioner. Recognition as a foreign main proceeding provides the foreign debtor with the immediate benefit of the automatic stay over the debtor’s U.S. assets under the U.S. Bankruptcy Code.

    If the debtor’s center of main interest in not in the same location as the pending foreign proceeding, the debtor is required to have some kind of “establishment” in said foreign country. Section 1502(2) of the U.S. Bankruptcy Code defines “establishment” as “any place where the debtor carries out a nontransitory economic activity.” This is a very low threshold and is a fact based determination. The foreign debtor in a non-main proceeding does not automatically benefit from the automatic stay, but can petition the bankruptcy court to impose the automatic stay.

    Once recognized under chapter 15, a foreign proceeding will be enforced unless “manifestly contrary to the public policy of the United States.”

  15. Can debtors incorporated elsewhere enter into restructuring or insolvency proceedings in the jurisdiction?

    A debtor incorporated elsewhere may enter into a United States restructuring proceeding pursuant to section 109(a) of the U.S. Bankruptcy Code if the debtor either resides or has a domicile, place of business, or property in the United States. A filing party only needs to meet one of these requirements to be eligible to be a debtor under the U.S. Bankruptcy Code. For a foreign corporation to be eligible for bankruptcy relief on the grounds that it has a place of business in the United States the debtor need only have a place of business, it does not need its primary location to be in the United States.

    The most relevant inquiry for a foreign debtor is what constitutes the possession of property within the United States for the purposes of Bankruptcy relief. The property requirement has been construed very broadly and almost any form of property will grant eligibility. The possession of property determination is made with regard to the time of filing.

  16. How are groups of companies treated on the restructuring or insolvency of one of more members of that group? Is there scope for cooperation between office holders?

    Under section 105(a) of the U.S. Bankruptcy Code, the bankruptcy court has the power to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the U.S. Bankruptcy Code.” Bankruptcy Rule 1015(b) provides, in pertinent part, that “[i]f… two or more petitions are pending in the same court by or against… a debtor and an affiliate, the court may order a joint administration of the estates.” Debtor groups, parents and subsidiaries, or otherwise, with an integrated operation may seek a joint administration of their chapter 11 cases for administrative convenience. This involves combining estates into a single docket for administrative matters “including a listing of filed claims, and the combination of notices to creditors of the different estates, and the joint handling of other purely administrative matters that may aid in expediting the cases and rendering the process less costly.” A joint administration reduces costs and fees associated with duplicative filings and objections. Most importantly, joint administrative does not adversely affect the debtors’ creditors’ rights because it is merely an administrative, not substantive, consolidation of the debtors’ estates. A creditor with a claim against one party has no rights to distribution payments from the estate of another party to the joint administration. Joint administration is merely a procedural devise used to expedite cases more efficiently. Without a specific court-ordered consolidation of estates, the assets of one entity may not be used to satisfy the debts of another involved in the joint administration.

    A court may substantively consolidate different debtor estates. This is a doctrine of equity undertaken when the estates are too intermingled to separate and establishes a single fund from which all claims from all debtors are paid. Under Bankruptcy Rule 1015(b):

    • Consolidation of the estates of separate debtors may sometimes be appropriate, as when the affairs of an individual and a corporation owned or controlled by that individual are so intermingled that the court cannot separate their assets and liabilities. Consolidation, as distinguished from joint administration, is neither authorized nor prohibited by this rule since the propriety of consolidation depends on substantive considerations and affects the substantive rights of the creditors of the different estates. The issue of substantive consolidation is fact-specific and not approved easily.
  17. Is it a debtor or creditor friendly jurisdiction?

    While the U.S. is generally considered a debtor-friendly jurisdiction, fundamental notions of due process underlie the U.S. Bankruptcy Code, ensuring that creditors are sufficiently protected throughout the bankruptcy process. There are many features of the U.S. Bankruptcy Code that make the U.S. a more debtor-friendly than certain foreign jurisdictions, including:

    • chapter 11 of the U.S. Bankruptcy Code allows companies to reorganize as going concerns instead of liquidating;
    • existing management is generally allowed to continue running the businesses instead of being automatically replaced by a trustee or other third party;
    • decisions of debtors in possession are afforded significant deference by bankruptcy courts under the “business judgment standard;”
    • the U.S. insolvency regime allows for the impairment of almost all levels of debt, including secured debt; and
    • the debtor is granted an exclusivity period of up to 20 months to file and solicit a plan of reorganization under section 1121 of the U.S. Bankruptcy Code, which often gives the debtor significant control over the reorganization process.

    The U.S. Bankruptcy Code balances these provisions with safeguards designed to protect creditors. For example, the U.S. Bankruptcy Code requires extensive notice procedures to put all relevant creditors on notice prior to comprising their claims, rejecting their contracts, or taking any other action that may impact their property. Additionally, recent amendments to the U.S. Bankruptcy Code cap the debtor’s ability to continuously extend the exclusive periods to file and solicit a plan of reorganization. By cutting limiting the debtor’s exclusivity periods, creditors are guaranteed an opportunity to direct the outcome of the case if the debtor is unable to timely implement a successful reorganization.

  18. Do sociopolitical factors give additional influence to certain stakeholders in restructurings or insolvencies in the jurisdiction (e.g. pressure around employees or pensions)? What role does the state play in relation to a distressed business (e.g. availability of state support)?

    Any influence that certain creditor constituencies enjoy under the U.S. restructuring regime is largely a product of the U.S. Bankruptcy Code as a matter of law—and less on a case-by-case basis. U.S. Bankruptcy Code sections 1113 and 1114, for instance, provide special protections for employees governed by a collective bargaining agreement or retirees receiving health or pension benefits. Debtors may reject collective bargaining agreements not pursuant to the generally applicable business judgment rule, but only if the court finds that (a) employee representatives lacked good cause to reject modifications, and (b) the balance of the equities clearly favors rejection. Debtors similarly may modify retiree health benefits only if the balance of the equities favors modification. Section 1114 permits interested parties to reinstate retiree health or pension benefits if they were improperly modified, prepetition. Further, section 365 of the U.S. Bankruptcy Code affords special protections to lessors by requiring debtors to continue paying postpetition rent until a commercial lease is rejected. Commercial leases that are not assumed within 120-days after the petition date are automatically rejected—unlike other executory contracts that may be assumed or rejected at or before plan confirmation.

    Additionally, the U.S. government plays a role in all bankruptcy cases through the United States Trustee Program of the Department of Justice (“USTP”). USTP attorneys serve monitoring, protective, and administrative functions by actively monitoring in-court bankruptcy proceedings to ensure compliance with the U.S. Bankruptcy Code—such as rules governing professional fee applications and debtor financial disclosures (e.g., monthly operating statements and schedules and statements). USTP attorneys also routinely monitor and object to chapter 11 debtor plan provisions, including most frequently release, injunction, and exculpation provisions—thereby ensuring that debtors do not unfairly abuse the U.S. Bankruptcy Code. In an administrative role, USTP attorneys appoint official creditor and equity committees, appoint and monitor case trustees in chapter 7 liquidations, and refer matters to the Department of Justice for criminal prosecution where appropriate. Additionally, while individual states are often more active participants in chapter 9 municipal bankruptcies, the federal government has exerted influence only in very select circumstances, such as certain of the automotive industry bankruptcies during the financial crisis of the late 2000s.

  19. What are the greatest barriers to efficient and effective restructurings and insolvencies in the jurisdiction? Are there any proposals for reform to counter any such barriers?

    As the U.S. restructuring industry has matured, sophisticated investors and professionals have developed strategies that maximize returns and professional fees, sometimes to the detriment of an efficient resolution of the restructuring. Sophisticated investors and restructuring professionals on all sides are able to pursue protracted and expensive litigation in order to extract “hold-up” value for creditors and generate large fees for professionals. Such investors typically engage in large chapter 11 cases by forming ad hoc committees with similarly interested investors, or seeking the appointment of an official committee, whose legal fees are satisfied by the debtor’s estate. By successfully forming committees, investors are able to challenge confirmation of a plan, challenge the debtor’s ability to sell substantially all of its assets to third parties, and in certain circumstances pursue direct and indirect litigation to prolong the cases and create uncertainty of outcome. For ad hoc groups or individual creditors, the desire to engage in protracted litigation to extract additional value is tempered by the cost of such litigation and the risk of potentially losing. For official committees, however, there is less fee risk as official committee fees are borne by the estate. To combat this, Congress would need to implement a mechanism that penalizes the groups engaging in frivolous litigation and/or jeopardizes the ability of official committees to recover their fees from the estate.