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/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?

    Generally, Article 9 of the Uniform Commercial Code (the “UCC”) – enacted in all fifty states – governs secured transactions in which security interests are created and perfected over movable or immovable property. In order to perfect a security interest, the secured party must file a UCC-1 financing statement (the “UCC-1”). While each state has different, specific filing requirements, the UCC-1 is generally filed with the secretary of state in the state where the debtor is located and often needs only three pieces of information: (i) the debtor’s name and address, (ii) the creditor’s name and address and (iii) a description of the collateral. By filing the UCC-1, the creditor is deemed to have provided public notice that it has an interest in the property of said debtor. The filing of a UCC-1 remains in effect until it is terminated by law (which in most cases, occurs five years after the initial filing unless continued by the filing of a continuation statement) or by the filing of a termination statement. A creditor can also extend the effectiveness of a UCC-1 beyond five years with a UCC-3 Continuation Statement.

    If a creditor fails to properly record its interest under the relevant state law requirements, the filing may be considered insufficient to provide the requisite notice to other creditors and thus deemed unenforceable against them, and the security interest may be avoided in bankruptcy. Common mistakes in filing include failure to file under the debtor’s correct legal name, failure to file in the appropriate jurisdiction or failure to list the debtor’s address. Even small mistakes in the debtor’s name, such as a single incorrect letter or punctuation mark may be deemed insufficient.

    Article 8 of the UCC governs the ownership of investment property such as securities and provides that a security interest is generally granted through control or possession. With regards to real property, security is generally effectuated through the relevant state and local laws, such as a real estate deed of trust or mortgage filing.

  2. What practical issues do secured creditors face in enforcing their security (e.g. timing issues, requirement for court involvement)?

    A secured creditor may enforce its security in a number of ways, most of which are governed by state law. As noted above, for the security interest to be valid, it must first be validly perfected through the applicable process – usually through the filing of a UCC-1, by taking possession, or through a mortgage or trust deed. If a creditor fails to properly perfect its security interest, its claim will be stripped of secured status and instead be deemed an unsecured claim against the debtor’s estate. Article 9 of the UCC also permits a secured party to repossess collateral through self-help measures when doing so would not breach the peace.

    Once a debtor is in bankruptcy proceedings, however, as discussed more thoroughly below, section 362 of the United States Bankruptcy Code (the “Bankruptcy Code” or the “Code” ) – the automatic stay – generally prohibits creditors from taking action to enforce their security interests. In certain circumstances, upon filing a motion and a hearing, the court may provide a creditor relief from the stay.

  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?

    In the U.S., one of two insolvency tests is typically applied: (i) the equitable insolvency test, which is generally defined as the debtor’s inability to pay debts when due and (ii) the balance sheet insolvency test, which examines the balance sheet of the debtor to determine if the amount of the debtor’s liabilities exceeds the value of its assets. The United States, however, does not have an insolvency requirement; thus, a debtor need not be insolvent to commence proceedings.

    The balance sheet test defines “insolvent” as a financial condition such that the sum of the debtor’s debts is greater than all of the debtor’s property at a fair valuation. Generally, the value of goods is assessed at “fair market value” and courts have adopted a rather flexible approach in analyzing a debtor’s insolvency. Courts tend to value companies that continue to operate day-to-day on a going concern basis. Under the equitable insolvency test (also referred to as the cash flow test), a debtor will be deemed insolvent if the company is unable to produce sufficient cash to pay debts as they become due. The cash may come from the disposition of assets, continuing operations, or other capital raises. Courts have not decidedly determined how far in the future the assessment should be made.

    U.S. law does not impose an obligation on a company’s board to commence insolvency proceedings and provides the board with the latitude to pursue alternative strategies in good faith to maximize the value of the company. Generally, directors and officers of a company owe a fiduciary duty only to its shareholders, not to creditors. However, when a company is insolvent, some states’ laws expand the fiduciary duties of the directors and officers of a company to include creditors as well as shareholders. The State of Delaware, for example, has ruled that directors of a solvent debtor operating in the “zone of insolvency” must discharge their fiduciary duties to the corporation and its shareholders. Thus, only when the debtor actually becomes insolvent do such duties shift to creditors as well. Apart from having a fiduciary duty, so long as directors continue to operate the business in good faith, they cannot be held liable. Most courts adopt the view that creditors are sufficiently protected by virtue of the protections in their contractual arrangements and that additional protections are not necessary.

  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 following proceedings govern insolvency proceedings in the United States:

    • Liquidation: Chapter 7 governs liquidations and applies to individuals and corporations.  Once a chapter 7 petition is filed and the proceeding is commenced, the automatic stay is immediately triggered, preventing any creditors from taking enforcement actions against the debtor.  Once the case is commenced, the management and board are displaced and a trustee is appointed.  The trustee is charged with marshalling and liquidating the debtor’s assets, but he/she may also continue to operate the debtor’s business for a period of time if it is in the best interests of the estate and is consistent with an orderly liquidation.  After providing notice to all creditors, the trustee will also convene a meeting of creditors, assess and liquidate assets and distribute them to creditors.  The length of time it takes to complete a chapter 7 liquidation depends on the assets and liabilities of a given debtor and the complexity of the liquidation and distribution.
    • Municipal reorganization: Chapter 9 governs municipal bankruptcies (states and the federal government may not file under chapter 9).  In order to file, the municipality must (i) be authorized under state law to file, (ii) be insolvent, (iii) desire to effect a plan to adjust its debt and either (a) have obtained an agreement with creditors holding at least a majority in amount of claims in each class that the entity intends to impair and have negotiated in good faith or demonstrated that negotiations are impractical or (b) believes that a creditor may attempt to obtain a transfer that is avoidable as a preferential transfer.  The commencement of a chapter 9 proceeding also triggers the automatic stay but is much broader for a chapter 9 debtor and applies to actions or proceedings against officers or inhabitants of the municipality.  Under chapter 9, a plan of arrangement is confirmed which is similar to a chapter 11 plan, but has some notable differences including that the absolute priority rule does not apply because a municipality does not have shareholders.  
    • Reorganization of corporations and individuals: Chapter 11 governs voluntary reorganization, focusing on the continued operation rather than the liquidation of the entity.  Generally, the entity continues to operate as a debtor-in-possession, with the goal of ultimately restructuring its pre-petition obligations in order to emerge from bankruptcy with a stronger balance sheet and more manageable obligations.  The ultimate goal is the approval of a chapter 11 plan, which, during the first 120 days, the debtor has the exclusive right to propose (and may be extended for another 18 months).  The length of time varies considerably depending on the  complexity and size of the case. 
    • Restructuring debt of farmers and fisherman: Chapter 12 governs “family farmers” or “family fishermen” with “regular annual income.”  Chapter 12 is a more streamlined process than chapter 11 or chapter 13 in order to address the specific needs of family farmers or fishermen and to allow them to propose a plan and make installments to creditors over three to five years. 
    • Restructuring debt of individuals: Chapter 13 governs individuals, allowing those with income to develop a plan to repay his or her debts, usually on a timeline of three to five years depending on the debtor’s median income, and in no event longer than five years.  While undergoing the repayment process, the law prohibits creditors from pursuing collection efforts. 
    • Cross-border insolvencies: Chapter 15 governs cross-border insolvencies and largely implemented the United Nations Commission on International Trade Law (“UNCITRAL”) Model Law on Cross-Border Insolvencies (the “Model Law”) into domestic law, with the aim of providing a simplified process for the recognition of insolvency proceedings initiated in a different country.  Once commenced, the chapter 15 proceeding allows the debtor to seek the protection of the automatic stay, thus protecting any assets located in the territorial jurisdiction of the U.S.      

    The following proceedings govern insolvency proceedings in the United States:

    • Liquidation: Chapter 7 governs liquidations and applies to individuals and corporations. Once a chapter 7 petition is filed and the proceeding is commenced, the automatic stay is immediately triggered, preventing any creditors from taking enforcement actions against the debtor. Once the case is commenced, the management and board are displaced and a trustee is appointed. The trustee is charged with marshalling and liquidating the debtor’s assets, but he/she may also continue to operate the debtor’s business for a period of time if it is in the best interests of the estate and is consistent with an orderly liquidation. After providing notice to all creditors, the trustee will also convene a meeting of creditors, assess and liquidate assets and distribute them to creditors. The length of time it takes to complete a chapter 7 liquidation depends on the assets and liabilities of a given debtor and the complexity of the liquidation and distribution.
    • Municipal reorganization: Chapter 9 governs municipal bankruptcies (states and the federal government may not file under chapter 9). In order to file, the municipality must (i) be authorized under state law to file, (ii) be insolvent, (iii) desire to effect a plan to adjust its debt and either (a) have obtained an agreement with creditors holding at least a majority in amount of claims in each class that the entity intends to impair and have negotiated in good faith or demonstrated that negotiations are impractical or (b) believes that a creditor may attempt to obtain a transfer that is avoidable as a preferential transfer. The commencement of a chapter 9 proceeding also triggers the automatic stay but is much broader for a chapter 9 debtor and applies to actions or proceedings against officers or inhabitants of the municipality. Under chapter 9, a plan of arrangement is confirmed which is similar to a chapter 11 plan, but has some notable differences including that the absolute priority rule does not apply because a municipality does not have shareholders.
    • Reorganization of corporations and individuals: Chapter 11 governs voluntary reorganization, focusing on the continued operation rather than the liquidation of the entity. Generally, the entity continues to operate as a debtor-in-possession, with the goal of ultimately restructuring its pre-petition obligations in order to emerge from bankruptcy with a stronger balance sheet and more manageable obligations. The ultimate goal is the approval of a chapter 11 plan, which, during the first 120 days, the debtor has the exclusive right to propose (and may be extended for another 18 months). The length of time varies considerably depending on the complexity and size of the case.
    • Restructuring debt of farmers and fisherman: Chapter 12 governs “family farmers” or “family fishermen” with “regular annual income.” Chapter 12 is a more streamlined process than chapter 11 or chapter 13 in order to address the specific needs of family farmers or fishermen and to allow them to propose a plan and make installments to creditors over three to five years.
    • Restructuring debt of individuals: Chapter 13 governs individuals, allowing those with income to develop a plan to repay his or her debts, usually on a timeline of three to five years depending on the debtor’s median income, and in no event longer than five years. While undergoing the repayment process, the law prohibits creditors from pursuing collection efforts.
    • Cross-border insolvencies: Chapter 15 governs cross-border insolvencies and largely implemented the United Nations Commission on International Trade Law (“UNCITRAL”) Model Law on Cross-Border Insolvencies (the “Model Law”) into domestic law, with the aim of providing a simplified process for the recognition of insolvency proceedings initiated in a different country. Once commenced, the chapter 15 proceeding allows the debtor to seek the protection of the automatic stay, thus protecting any assets located in the territorial jurisdiction of the U.S.
  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 absolute priority rule under the U.S. Bankruptcy Code requires that creditors are paid before shareholders in accordance with their respective priorities. Thus, secured creditors are entitled to recovery before unsecured creditors, and unsecured creditors are entitled to recover over shareholders. However, the Bankruptcy Code does provide that certain stakeholders with general unsecured claims are entitled to priority payment. Those claims include administrative expenses (including judicial fees and costs), employee wages earned in the 180 days prior to a bankruptcy filing, unpaid contributions to employee benefits plans earned in the 180 days prior to a bankruptcy filing and certain prepetition taxes. The Bankruptcy Code also affords certain claims a “superpriority” status, such as claims for failure to provide adequate protection and claims on account of postpetition financing. Finally, certain provisions of the Bankruptcy Code provide protection for certain creditors such as aircraft financiers, and contain safe harbour provisions to allow derivative contract counterparties to exercise setoff rights and liquidate or terminate contracts after the commencement of the proceeding.

    The court may change the treatment of certain creditors’ claims through equitable subordination, recharacterization or substantive consolidation. Equitable subordination subordinates the claim to other similarly situated claims, thus lowering the claim’s priority, if it is shown that the claim holder engaged in wrongful conduct that resulted in harm to other creditors. In the case of recharacterization, the court allows a claim on account of its substance rather than its form (i.e. if claims have attributes that suggest it should be characterized differently). Finally, a court may substantively consolidate an estate, combining the assets and liabilities of more than one debtor, which may eliminate intercompany claims or change relative recoveries or structural priority between the claimants of the various entities.

  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, the debtor or trustee is empowered to avoid preferential, fraudulent, certain security interests, and post-petition transfers made without court authorization.

    Preferential transfers are those that are made 90 days before the commencement of the case (or within one year for transfers to insiders) on account of an already existing debt that gives the recipient of the transfer a greater recovery than it would have received through a liquidation process. If the court deems such a transfer an improper preference, it will be unwound and the court will award the plaintiff with a claim for money damages.

    There are two types of fraudulent transfers: constructive and actual. Transfers that are actually fraudulent are made “with actual intent to hinder, delay or defraud any creditor” whereas they are deemed constructive if the debtor received less than equivalent value in exchange, the debtor was insolvent at the time the transfer was made or became insolvent as a result and the debtor was left with unreasonably small capital or the debtor intended or believed it would incur debts beyond its ability to pay. The Bankruptcy Code’s fraudulent transfer look back period is two years, but permits a longer period if available under state law and can extend to six years.

    The debtor (or trustee) is empowered under § 544 if the U.S. Bankruptcy Code with the so called “strong-arm powers.” Under § 544(a), a debtor is treated as if it were a judicial lien holder as of the petition date, and as such can avoid the security interest of any creditor that would lose to a lien creditor under nonbankruptcy law. Section 544(b) allows the debtor to step into the shoes of any actual creditor in the case and avoid any transfer that creditor could have voided under applicable nonbankruptcy law.

    While avoidance actions are considered the property of the estate, courts are willing to grant standing to third parties to pursue such claims. To be granted standing, the party must show that a valid claim exists, that the creditor has made a demand upon the debtor to pursue a claim but the debtor has refused and that it is in the best interests of all creditors that the claim be pursued.

  7. What form of stay or moratorium applies in insolvency proceedings against the continuation of legal proceedings or the enforcement of creditors’ claims? Does that stay or moratorium have extraterritorial effect? In what circumstances may creditors benefit from any exceptions to such stay or moratorium?

    Upon the filing of a bankruptcy proceeding, the automatic stay is triggered, thereby protecting the debtor and the property of the estate. Subject to certain exceptions, at that point, no creditors may pursue collection efforts, foreclosure actions or other enforcement actions against the debtor without first obtaining authority from the court. Section 362 of the Bankruptcy Code provides that a creditor may not “create, perfect, or enforce” a lien against the estate, thereby preventing all creditors, subject to certain exceptions, from taking any action to enforce a security interest or improve its position relative to other creditors after the filing of the bankruptcy petition. The automatic stay expressly prohibits acts to obtain possession of “property of the estate,” thus generally barring creditor collection efforts with respect to estate property located both within and outside the U.S.

    The Code provides certain exceptions to the automatic stay under section 362(b), including criminal proceedings, enforcement of a governmental unit’s police or regulatory powers, and a non-debtor party’s right to close out securities or financial contracts, among others. Similarly, pursuant to section 362(d), upon the creditor’s request and following a hearing, the court may grant relief from the automatic stay in the following circumstances: (i) “for cause” such as lack of adequate protection, (ii) if the debtor does not have equity in the property and the property is not necessary to effectively reorganize, (iii) with respect to a stay of an act against single asset real estate in certain circumstances and (iv) where with respect to a stay of an act against real property, under certain circumstances the bankruptcy was part of a scheme to hinder, defraud creditors.

  8. 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?

    As noted above, companies seeking to restructure generally initiate a voluntary chapter 11 proceeding. After filing, the management of the debtor remains in place and continues to have the authority to make decisions on behalf of the company.

    Initially, the debtor is the only party with the authority to present and solicit a restructuring plan, which specifies the treatment and manner of distributions. This exclusive period provides a debtor with a 120 day “breathing spell” after the commencement of the bankruptcy proceeding to present a plan and an additional 60 days to solicit votes on the plan. This period may also be extended for up to 18 months from the date of the filing. Once the exclusive period ends, any party is able to present a plan. In order to seek votes from creditors, the court must first approve of the debtor’s disclosure statement, which provides voting parties with the necessary information to vote on the plan. For a plan to be approved, in addition to the plan complying with applicable provisions of the Bankruptcy Code, either (a) each impaired class must approve the plan by at least two-thirds in dollar amount and by more than 50% of the number of voting creditors, or (b) at least one impaired class must accept the plan and the court must determine the plan does not “discriminate unfairly” and is “fair and equitable” to non-accepting dissenting classes. After a plan has been approved by creditors, the court must also approve it. The plan then becomes effective and the debtor exits bankruptcy as a reorganized debtor.

    The bankruptcy court plays a very active role in the restructuring process and, as demonstrated above, ultimately approves the plan that allows the debtor to exit restructuring. For instance, valuation of the debtor’s estate is integral to formation and confirmation of the plan of reorganization. Because judges are not generally thought to be experts at valuing companies, the role of the court is generally viewed as being to police the process that leads to valuation of the company to ensure that the resulting proposed plan is within the range of confirmable plans. The U.S. Department of Justice also appoints a trustee (the “U.S. Trustee”), which examines the proceedings for procedural and substantive fairness, and various creditor constituencies also play a very important role in the process.

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

    A debtor-in-possession is permitted to obtain new financing. A debtor may obtain post-petition unsecured financing in the ordinary course of business and does not need the approval of the court in order to do so. Such financing will be treated as an administrative expense under 503(b)(1) of the Code. A debtor-in-possession may also obtain secured credit and the court may authorize liens that are junior, senior or equal to existing liens if the debtor can demonstrate that it is unable to obtain credit elsewhere. The debtor must also provide “adequate protection” to any other creditor with an existing lien over the collateral being pledged in order to compensate the creditor for any diminution in value of the collateral.

  10. Can a restructuring proceeding release claims against non-debtor parties (e.g. guarantees granted by parent entities, claims against directors of the debtor), and, if so, in what circumstances?

    Releases of non-debtors—or third-party releases—are permitted under the Bankruptcy Code in some circumstances, but courts disagree about the extent to which these third-party releases are permissible. Section 1123 of the Code provides that a plan may “provide for 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 Code. Similarly, section 105(a) provides that a bankruptcy court “may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” Thus, there is statutory support for the allowance of third-party releases.

    Generally, the most common form of third-party releases are for directors and officers of the debtors. Claims held by debtors against these “insiders” are generally permitted if the release is considered procedurally and substantively fair. Similarly, releases that require the consent of affected creditors are generally allowed, but courts disagree about acceptable forms of consent. Some courts take a narrower and more strict view of consent, requiring that creditors affirmatively approve the plan to demonstrate their consent, while other courts take a more broad view of consent and have held that unimpaired creditors or creditors who do not vote on the plan or do not object are considered to have consented.

    In some limited circumstances, courts in some jurisdictions will allow non-consensual third party releases if the court considers such releases necessary to the debtor’s successful reorganization.

  11. Is it common for creditor committees to be formed in restructuring proceedings and what powers or responsibilities to they have? Are they permitted to retain advisers and, if so, how are they funded?

    In chapter 11 cases, the U.S. Trustee is generally required to appoint a committee of unsecured creditors and has the authority to appoint other committees if it sees fit, though this requirement is not often observed in “pre-packaged plan” cases. The official creditor’s committee is generally comprised of five to seven creditors, selected from the debtor’s 20 largest creditors. This committee serves as a fiduciary for the unsecured creditors and performs oversight functions such asinvestigating the debtor’s acts, conduct, assets, liabilities and other matters of relevance to the development of the plan. If the court approves, the committee may retain legal and financial counsel, with those expenses paid from the debtor’s estate. Unofficial or ad-hoc committees are also often formed in restructuring proceedings, but they are self-appointed and self-regulating. While these committees often retain legal and financial counsel as well, the debtor is not necessarily required to pay their expenses. However, if the court finds that the ad-hoc committee made a “substantial contribution” to the case, the debtor may be required to pay their expenses as well.

  12. 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?

    Upon notice and a hearing, the debtor may reject most pre-petition executory contracts or leases, subject to a business judgment test, which is highly deferential to the decisions of the debtor. In most circumstances, a debtor has until confirmation of the plan to assume or reject executory contracts and until that time, both parties must continue to perform under the contract regardless of whether the debtor has paid outstanding prepetition amounts or not.

    If the debtor chooses to assume the contract, it is responsible for all pre and post-petition defaults and is bound by the contract going forward. Should the debtor reject the contract, the debtor is no longer bound but the rejection is considered a pre-petition breach that results in an unsecured claim for damages. If the debtor chooses to continue to receive benefits from a counterparty pending the decision to assume or reject the contract, the debtor is required to continue paying for the reasonable value for such services. Further, claims from contract counterparties who supply such goods or services pursuant to a contract are afforded administrative priority to the extent that the goods or services were provided during the reorganization.

  13. 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? Are pre-packaged sales possible?

    Under Section 363 of the Bankruptcy Code, debtors are able to sell some or all of their assets. Those sold in the ordinary course of business do not require court approval while those sold outside the ordinary course do require notice, a hearing, and court approval. Debtors are required to demonstrate a legitimate business reason for the sale – a standard which is relatively flexible, as courts consider many relevant factors pertaining to the proceeding and the proposed sale.

    Debtors may also sell their assets pursuant to the chapter 11 restructuring plan. Selling assets under section 363 of the Code allows property to be transferred to a buyer “free and clear” of all liens and encumbrances if the debtor can show (a) it is permitted under nonbankruptcy law; (b) the 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.

    The Code also permits a holder of a lien securing an allowed claim to “credit bid” its interest, generally up to the face amount of its secured claim—in most cases, regardless of what the claim holder actually paid for the claim.

  14. What duties and liabilities should directors and officers be mindful of when managing a distressed debtor? What are the consequences of breach of duty? Is there any scope for other parties (e.g. director, partner, shareholder, lender) to incur liability for the debts of an insolvent debtor?

    As noted above, directors and officers generally only have fiduciary duties to their shareholders and the corporation, not to creditors. Only when the company is insolvent do some states expand a director or officer’s duty of loyalty to include creditors.

    Depending on the state law where the corporation is incorporated, directors and officers generally also have a duty of care and a duty of loyalty. The duty of loyalty requires that directors and officers act in good faith in the best interests of the corporation, prohibiting directors from taking actions that are self-interested or to engage in self-dealing transactions. The duty of care requires that directors adhere to a reasonable standard of care and exercise the reasonable amount of caution, watchfulness and attention in conducting the affairs of the company. Regardless of whether the company is solvent or insolvent, the business judgment rule generally applies, which assumes that in making decisions for the company, the directors and officers are operating rationally, in good faith and for the best interests of the company.

    While the board of directors in most cases continues to run the company post-petition, the U.S. Trustee is charged with overseeing the administration of the bankruptcy proceeding. While the board remains in position and continues to have the authority to make decisions on behalf of the company, the U.S. Trustee does have the authority to examine actions of the board and object to the court.

    It is presumed that directors, partners, parent entities, shareholders (including parent companies) and lenders will not be held liable for the liabilities of a corporation. However, directors, partners, parent entities and/or lenders may be held liable for a number of reasons.

    It is possible for other parties to incur liabilities if a court disregards the corporate forum and “pierces the corporate veil.” All courts analyze the doctrine of “piercing the corporate veil” differently, but generally the common considerations are 1) whether there was a fraud or injustice perpetuated in the use of the corporate forum and 2) whether evidence of complete domination and control exist such that the corporation is regarded to be a shell, instrumentality or alter ego of the parent corporation. Courts consider many factors when determining whether the veil can be pierced, but do so on a case by case basis. Generally courts look for evidence of (i) the failure to observe corporate formalities; (ii) the undercapitalization of the corporation; (iii) intermingling of corporate funds; (iv) shared corporate directors, officers, personnel, office spaces and services; (v) common use of property and assets; (vi) the corporation’s ability to make decisions for itself; (vii) the arm’s length nature of interactions and transactions between the parent and company; (viii) whether the corporation is profitable by itself; and/or (ix) guarantees granted by the parent to the subsidiary. The presence of one factor or more does not indicate the veil should be pierced in itself.

    A director’s failure to ensure certain taxes, such as payroll taxes, are being paid may also impute liability to them under federal or state law. Corporations are required to withhold employee taxes and pay them directly to the government. Not doing so could lead to personal liability on those responsible for this misuse.

    As for lenders, typically there are no fiduciary duties imputed in a debtor-creditor relationship. Nevertheless, if the debtor’s operations, finances, corporate policy and/or disposition of assets are being controlled or dominated by the lender, it could lead to the lender’s liability. In these cases lenders’ claims have been equitably subordinated, recharacterized or avoided. At worst, a lender could be found to be liable for damages to the debtor.

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

    As noted above, a debtor may seek various forms of releases for prepetition claims and causes of action in a plan of reorganization. Section 1123 of the Code states 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 Code. Releases tend to be either a debtor release or a third-party release and third-party releases may be consensual or non-consensual. Each type of release is subject to different legal standards.

    Releases by debtors to non-debtor, non-insiders are subject to the business judgment standard and thus given broad deference, whereas debtor releases against insiders are often held to a slightly higher standard.
    Consensual third-party releases are generally permitted, but courts differ on what is “consensual” with some courts construing it very narrowly and others taking a broader view of what “consent” means. For the most part, non-consensual third-party releases are permitted only in rare cases, and in some jurisdictions are not permitted at all.

  16. 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? Has the UNCITRAL Model Law on Cross Border Insolvency been adopted or is it under consideration in your country?

    A U.S. court will recognize a foreign proceeding if the debtor seeks recognition of the foreign proceeding through chapter 15 of the Code, which Congress adopted to implement the UNCITRAL Model Law, with some modifications. The requirements under section 1517 for recognition of a foreign proceeding are relatively straightforward and require that the foreign proceeding is (i) a proceeding, (ii) judicial or administrative, (iii) collective in nature, (iv) conducted in a foreign country, (v) pursuant to local law relating to bankruptcy or the adjustment of debt, (vi) in which the debtor’s assets are subject to control or supervision by the courts and (vii) which is for the purpose of liquidation or reorganization.

    In recognizing a foreign proceeding, the court must determine if the foreign proceeding is a “foreign main” or “foreign non-main” proceeding. Courts recognize a foreign proceeding as the debtor’s main proceeding if the foreign proceeding is in the jurisdiction where the debtor has its “center of main interests” (“COMI”). While the Code does not define COMI, courts have considered several factors in making a COMI determination. Generally, the Debtor’s registered office (or habitual residence in the case of an individual) is presumed to be its COMI, but that presumption is rebuttable with evidence to the contrary. Courts also examine the location of those who actually manage the affairs of the debtor, the location of a majority of the debtor’s creditors who would be affected by the case, the jurisdiction whose law would govern the disputes and the expectations of third parties with regard to a debtor’s COMI. Once a court recognizes a foreign proceeding as its foreign main proceeding, the debtor is afforded the immediate protection of the automatic stay for all of the debtor’s assets located in the territorial jurisdiction of the United States.

    For a foreign proceeding to be recognized as a debtor’s “nonmain” proceeding, the debtor need only establish that it has an “establishment” in that jurisdiction where it engages in non-transitory economic activity. Recognition of a nonmain proceeding does not afford the debtor with the protection of the automatic stay, but the debtor is permitted to petition the court for such protection, which the court may grant in its discretion.

    Once a foreign proceeding is recognized, chapter 15 generally provides that the U.S. court grant comity to and cooperate with the foreign courts. The court may refuse to grant any relief under chapter 15 if the action would be “manifestly contrary to public policy,” which courts have determined is a very high standard. Such public policy exception is very narrowly construed and only in exceptional circumstances do courts invoke it – usually when concerning matters of fundamental importance for the U.S. such as procedural fairness of the foreign proceeding or if granting the requested relief would impinge on a U.S. constitutional or statutory right.

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

    The only requirement for a foreign corporation to enter into insolvency proceedings in the United States is that the corporation has a domicile, place of business or property in the United States.
    With regards to the possession of property requirement, courts have interpreted it quite broadly, with most any property located in the United States at the time of filing the petition qualifying.

  18. 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?

    The Bankruptcy Code permits, and courts routinely allow, affiliated debtors or parents and subsidiaries with integrated operations to file jointly and seek joint administration of their chapter 11 cases, thus allowing debtors to combine all filings on one docket for administrative ease and cost efficiency. The joint filing and administration of a case is distinct from substantive consolidation, for joint administration does not allow a court to distribute group company assets pro rata without regard to the assets and liabilities of the individual corporate entities in the proceeding. Rather, when entities are jointly administered, the distributive value allocated to each entity within a corporate group depends on the assets and liabilities of each entity in the group and a creditor with a claim against one entity has no rights against another entity, as joint administration is merely a procedural efficiency.

    In contrast, substantive consolidation combines all assets and liabilities of a group of debtors into one estate for voting and distribution purposes, creating one fund from which all creditors of all entities are paid. U.S. courts generally only allow substantive consolidation when the various estates are too intermingled to properly distinguish amongst the entities.

  19. Is it a debtor or creditor friendly jurisdiction?

    The United States is widely perceived as debtor-friendly jurisdiction, illustrated in large part by the deference afforded debtors. The debtor-in-possession regime permits companies to reorganize as going concerns with existing management remaining in place and running the business as it deems fit with courts examining their actions under the flexible “business judgment standard.” Further, in chapter 11 proceedings, the debtor has the exclusive right to propose a plan for the first 120 days, which may be extended through the date that is 18 months after the filing of the chapter 11 petition..

  20. 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)?

    For the most part, sociopolitical factors do not provide tremendous additional influence to certain stakeholders. However, the Code itself does provide protections for certain constituencies. For example, debtors may not unilaterally terminate collective bargaining agreements, qualified registered pension plans and retiree benefits unless it is able to demonstrate that the modification is necessary to properly effectuate the reorganization.

    As noted above, a U.S. Trustee is appointed at the commencement of the case and is charged with overseeing the administration of the estates and able to object to certain actions of the debtor when necessary.

  21. 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?

    Prolonged and expensive litigation is the greatest barrier to effective restructurings in the United States. As noted above, expenses incurred by the official creditors’ committee are paid by the debtor’s estate rather than the committee members themselves, which can result in litigation or other similar actions that prolong the restructuring process and do not necessarily result in the most efficient process. Presently, there are no reform efforts in place to combat this inefficiency in the system.