The modifications made by this section will enable a trustee or debtor to commence a preference action against a trade creditor in order to reach the insider. However, any recovery or avoidance of a transfer shall only be valid against a creditor who is the insider of the debtor.

Reclamation And Return Of Goods

Credit grantors should be especially pleased by the legislation’s expansion of reclamation rights.

Section 406 – Amendment to Section 546 of Title 11, United States Code
Reassigns the second section currently designated as Bankruptcy Code Section 546(g) to Section 546(h). Under current law, a bankruptcy court may approve the debtor’s return of goods shipped by a creditor to the debtor before the commencement of the bankruptcy case, provided the creditor consents to the relief, and offsets the purchase price of such goods against any claim the creditor has against the debtor that arose prior to the commencement of the bankruptcy case. The new Section 546(h) modifies existing law by making the return of goods subject to the prior rights of holders of security interests in the goods or the proceeds of the goods.

Section 546 is further modified by adding a new Section 546(i), which provides that a trustee may not avoid a warehouseman’s lien for storage, transportation or other costs incidental to the storage and handling of goods. The prohibition against avoidance of such warehouseman’s and similar liens must be applied in a manner consistent with any state statute similar to UCC 7-209, which deals with warehouseman’s liens and security interest for charges and expenses. This modification serves to further limit a trustee’s avoidance power by exempting warehouseman’s liens and similar liens from a trustee’s Section 545 lien avoidance powers.

Section 1227 – Reclamation
Modifies Section 546(c) to provide that a trustee’s avoidance powers are subject to the rights of a seller of goods to reclaim goods sold to the debtor in the ordinary course of the seller’s business if the debtor received the goods, while insolvent, within 45 days of the commencement of the bankruptcy case and if the seller makes a written reclamation demand:

(i) no later than 45 days from the debtor’s receipt of the goods; or

(ii) no later than 20 days after the commencement of the bankruptcy case, if the 45-day period expires after the commencement of the bankruptcy case.

A seller’s reclamation rights are subject to the prior rights of a creditor with a security interest in such goods.

If the creditor fails to make a timely written reclamation demand as required above, or otherwise has no reclamation rights, the creditor may still assert an administrative expense claim pursuant to a newly enacted Section 503(b)(9). New Section 503(b)(9) provides that, after notice and a hearing, the creditor shall be granted an allowed administrative expense claim for the value of goods (but not services) received by a debtor within 20 days prior to the commencement of the bankruptcy case for goods sold to the debtor in the ordinary course of the debtor’s business.

The modifications to Section 546(c) and the addition of Section 503(b)(9) represent a significant enhancement of a seller’s ability to exercise its reclamation rights. The amendments change existing law by extending the time requirements for which written demand must be made to the debtor:

(i) from 10 days after receipt of goods by the debtor (under existing law) to 45 days from receipt of goods; and

(ii) from 20 days after receipt of goods by the debtor, if the 10-day reclamation period had not expired when the bankruptcy case was commenced (under existing law), to 20 days after the commencement of the bankruptcy case (if the 45-day period had not expired when the bankruptcy case commenced).

Under existing law, a creditor’s failure to make a timely written demand and otherwise satisfy the requirements for reclamation extinguishes its right to any remedy on account of its reclamation claim (e.g., return of the goods, or a replacement lien or an administrative claim in the amount of the reclamation claim). The amended Section 546(c) eliminates the remedy of granting a seller a lien or an administrative priority claim if the court declines to order return of the goods. Because reclamation rights are subject to the rights of a secured lender in the goods, it is questionable whether a secured lender will ever consent to the debtor’s return of goods free and clear of its security interest, absent which the right of reclamation might be a hollow remedy.

New Section 546(c)(2) also expressly provides that, notwithstanding a creditor’s failure to make a timely written reclamation demand, the creditor is still entitled to an administrative expense claim for the value of any goods received by the debtor in the ordinary course of the debtor’s business within 20 days of the commencement of the bankruptcy case. Section 503(b)(9) adds this as a new category of administrative expense claims that provides unsecured creditors a safety net in the form of an administrative claim for goods sold on credit and received by the debtor within 20 days of the filing of the commencement of the debtor’s bankruptcy case.

Chapter 11 Administration

Section 321 – Chapter 11 Cases Filed by Individuals
Although not generally known to the creditor community, Chapter 11 filing has always been available to individuals under the Bankruptcy Code. This usually will happen if the individual has assets and liabilities which exceed the Chapter 13 monetary limits. Further, a Chapter 11 is often used by an individual who is a sole proprietor and wishes to reorganize its business.

The legislation modifies Chapter 11 of the Bankruptcy Code by adding Section 1115 to include additional property of a debtor. That section states that property of an individual Chapter 11 debtor shall include:

As is the common concept behind a Chapter 11, the modification goes on to state that except under other provisions of the Bankruptcy Code or by way of a confirmed plan or order confirming a plan, the debtor shall remain in possession of its property.

Section 405 – Creditors and Equity Security Holders Committees
A change to Bankruptcy Code 1102 will be most welcome by commercial credit grantors. Bankruptcy Code 1102 currently states that only a United States Trustee can appoint a committee of creditors or equity security holders.

As many credit executives have experienced, obtaining a change of a committee or an additional committee by the United States Trustee was next to impossible. This left a creditor or group of creditors with only the option of seeking a court order directing the United States Trustee to appoint an additional committee. Yet, the actual appointment of any committee remained solely in the hands of the United States Trustee.

Section 1102(a) of the Bankruptcy Code is modified to broaden the powers of the Court relative to these committees. At the request of an interested party or parties, and after notice and a hearing, the Court will now have the power to direct the United States Trustee:

This change enables the small business which usually holds a claim of insufficient dollar amounts to be considered by the United States Trustee, to now sit on and participate on the creditors’ committee. We may see broader applications of this section as the amended statute becomes used.

Creditors’ committees’ responsibility to the general creditor body, in particular small businesses, has also been expanded. A creditors’ committee will now be required to:

Further, the court may order the committee to provide additional information, disclosure or a report to those creditors holding claims of the kind represented by that committee and are not appointed to the committee. Where in the past creditors who did not sit on a committee often felt they were left in the dark, this modification will aid creditors to obtain current and continuing information from a committee.

Section 416 – Appointment of Elected Trustee
Modifies Section 1104(b) (which permits creditors to elect a Chapter 11 trustee), to elaborate on the election procedure. It requires that the United States Trustee file a report certifying the election of a trustee by creditors in a Chapter 11 case. The trustee will be considered selected and appointed, and any previously appointed Chapter 11 trustee would be terminated as of the date the report is filed. The court must also resolve any dispute arising out of the election of a trustee by creditors. This subsection to Section 1104(b) is new.

Section 417 – Utility Service
Modifies Section 366 to provide a more detailed definition of “assurance of payment” for purposes of what a debtor must provide to a utility in exchange for the utility’s continued service. Under a new subsection 366(c)(1)(A) “assurance of payment” means: (i) a cash deposit; (ii) a letter of credit; (iii) a certificate of deposit; (iv) a surety bond; (v) a prepayment of utility consumption; or (vi) another form of security agreed to by the utility and the debtor. It also states that an administrative expense claim does not constitute an adequate assurance of payment. The amendment allows a utility to alter, refuse or discontinue service, after 30 days from the commencement of a Chapter 11 bankruptcy case, if the utility does not receive adequate assurance of payment satisfactory to the utility.

On request of a party in interest, the court may order modification of the amount of an assurance of payment. However, in making such a determination of the adequacy of such payment, the court may not consider: (i) the absence of security before the commencement of the bankruptcy case; (ii) the debtor’s timely payments to the utility prior to the commencement of the bankruptcy case; or (iii) the availability of an administrative expense priority.

The amendment allows a utility involved in Chapter 11 cases to recover or set off its pre-petition claim against any security deposit held by the utility prior to the date of commencement of the debtor’s Chapter 11 case, without notice or order of the court.

This amendment represents a significant modification to existing law concerning utility service to a Chapter 11 debtor. Under existing law, courts have established, through case law, the meaning of “assurance of payment.” In determining the meaning of this phrase, a significant number of jurisdictions have considered a debtor’s payment history prior to the commencement of the bankruptcy case, as well as any security deposits held by the utility providers. Often courts have determined that a utility’s protection through an existing cash deposit and the administrative expense claim a utility is entitled to for providing postpetition services amount to adequate assurance of payment. The amendment would overrule this entire line of court rulings and afford utility providers far greater protections.

Section 440 – Scheduling Conferences
Amends Bankruptcy Code Section 105(d) to provide that a bankruptcy court “shall” hold such status conferences as are necessary to further the expeditious and economical resolution of a case. Under existing law, the bankruptcy court is given discretion over whether to hold status conferences regarding any case or proceeding under the Bankruptcy Code.

Section 442 – Expanded Grounds for Dismissal or Conversion and Appointment of Trustee
Modifies Section 1112(b) by expanding the grounds that a court can rely upon to dismiss a Chapter 11 case, convert a Chapter 11 case to a case under Chapter 7, or appoint a trustee or examiner in a Chapter 11 case. While this provision is included among the small business changes, it applies to all Chapter 11 cases. A court is required to convert or dismiss a case (whichever is in the best interest of the estates) if a movant establishes “cause”. The amended Section 1112(b) provides a non-exhaustive list of 16 factors that may be a basis for finding “cause.” Included among these are:

(i) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation;
(ii) gross mismanagement of the estate;
(iii) failure to maintain appropriate insurance that poses a risk to the estate or to the public;
(iv) unauthorized use of cash collateral substantially harmful to one or more creditors;
(v) failure to comply with an order of the court;
(vi) unexcused failure to satisfy timely any filing or reporting requirement established by this title or by any rule applicable to a case under this chapter;
(vii) failure to attend the meeting of creditors convened under Section 341(a) or an examination ordered under Rule 2004 of the Federal Rules of Bankruptcy Procedure without good cause shown by the debtor;
(viii) failure to timely provide information or attend meetings reasonably requested by the United States Trustee (or the bankruptcy administrator, if any);
(ix) failure to timely pay taxes owed after the commencement of the bankruptcy or to file tax returns due thereafter;
(x) failure to file a disclosure statement, or to file or confirm a plan, within the time fixed by the Bankruptcy Code or by order of the court;
(xi) failure to pay any fees or charges required under Chapter 123 of Title 28;
(xii) revocation of an order of confirmation under Section 1144 of the Bankruptcy Code;
(xiii) inability to effectuate substantial consummation of a confirmed plan;
(xiv) material default by the debtor with respect to a confirmed plan;
(xv) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan; and
(xvi) failure of the debtor to pay any domestic support obligation that first become payable after the date of the filing of the bankruptcy case.

If the movant does establish cause, the court may only deny a motion to convert or dismiss the case if the debtor, or another party in interest, objects and establishes: (i) there is a reasonable likelihood that a plan will be confirmed within applicable timeframes; (ii) the grounds for granting the relief include an act or omission for which there exists a reasonable justification; and (iii) such act or omission will be cured in a reasonable time, and the court identifies unusual circumstances that establish that conversion or dismissal is not in the best interests of creditors and the estate. However, where the “cause” is substantial and continuing loss or diminution of the estate and the absence of a reasonable likelihood of rehabilitation, the court cannot deny dismissal or conversion.

The amendment requires the court to commence a hearing on a motion to dismiss or convert a Chapter 11 case not later than 30 days after the date the motion is filed. The court must decide the motion within 15 days after the commencement of the hearing. However, such hearing and ruling may be continued if: (i) the movant expressly consents to the continuance for a specific time; or (ii) compelling circumstances prevent the court from meeting these time requirements.

This amendment also modifies Section 1104(a) to permit a court to appoint a Chapter 11 trustee or examiner if grounds exist to convert or dismiss the Chapter 11 case under Section 1112 (as amended), and the court determines that the appointment of a trustee or examiner is in the best interests of creditors and the estate.

Section 1208 – Allowance of Administrative Expenses
Modifies Section 503(b)(4) to exclude as administrative expenses, claims made by a member of a creditors’ or equity committee for professional services rendered by an attorney or an accountant retained by such a member. The existing case law is not clear whether committee members are entitled to administrative expense claims for fees associated with professional services (i.e., legal and accounting) that were rendered to such member in connection with service on the committee.

Section 1401 – Employee Wage and Benefit Priorities
Modifies Section 507(a)(3) and (a)(4) to increase the cap on the amount of the priority claims for employees’ wages, salaries, commissions and employee benefits, up to $10,000. It also extends the period for determining such employees’ priority claims to compensation and benefits earned within 180 days of the commencement of the bankruptcy case or the date of cessation of the debtor’s business (whichever occurred first).

Under existing law, such employee wage, salary, commissions and benefit claims are afforded a priority status, subject to a $4,925 cap, and only for the period 90 days prior to the commencement of the bankruptcy case or the date of cessation of the debtor’s business (whichever occurred first).

Section 212 of the new legislation provides a new first priority administrative expense claim to certain domestic support obligations, which is applicable only to individual debtors. Accordingly, all of the existing categories of priority claims (e.g., administrative expenses, unsecured claims associated with the gap period in involuntary cases, employee claims, tax claims, etc.) have been moved down one level in priority. Existing Bankruptcy Code Section 507(a)(3) has been redesignated as Section 507(a)(4) and wages, salary and commissions claims subject to that section have been afforded a fourth priority and existing Section 507(a)(4) has been redesignated as Section 507(a)(5) and employee benefit claims subject to that section have been accorded a fifth priority.

Section 1403 – Payment of Insurance Benefits to Retired Employees
Amends Bankruptcy Code Section 1114 by limiting a debtor’s ability to modify its retiree benefits plan in the 180-day period prior to the debtor commencing a bankruptcy case. The amendment adds a new subsection (l) to Section 1114, which provides that if the debtor modified the retiree benefits plan in the 180-day period prior to the bankruptcy filing, and the debtor was insolvent on the date the retiree benefits plan was modified, then a party in interest may bring a motion for an order reinstating the benefits. The bankruptcy court may issue an order reinstating the benefits as of the date the modifications were made, unless the bankruptcy court finds that the balance of the equities clearly favor such modifications.

Plan Process

Section 408 – Postpetition Disclosure and Solicitation
Modifies Section 1125 to add a new Section 1125(g) to permit an entity to solicit acceptances or rejections of a plan from a holder of a claim or interest prior to a Chapter 11 filing if the holder of such claim or interest was solicited before commencement of the bankruptcy case in a manner complying with applicable nonbankruptcy law.

Under existing law, the solicitation of acceptances or rejections of a plan can be made after the bankruptcy filing only if such solicitation is accompanied by a court approved disclosure statement. This provision provides explicit statutory authority for a party to solicit acceptances or rejections prior to a bankruptcy case being filed, as is frequently done in a “prepackaged” Chapter 11 case.

Section 411 – Period for Filing Plan Under Chapter 11
Modifies Section 1121(d) by: (i) limiting the time for a debtor in a Chapter 11 case to have the exclusive right to file a Chapter 11 plan up to a maximum of 18 months following the commencement of the bankruptcy case; and (ii) limiting the time that a court may extend the period for a Chapter 11 debtor to have the exclusive right to solicit acceptances of a Chapter 11 plan the debtor filed during its exclusivity period up to a maximum of 20 months. These deadlines cannot be further extended by the court.

Under current law, there is no statutorily imposed outside time limits for exclusivity period extensions that a court may grant. Upon the request of a party in interest, the court may reduce or increase the 120-day and 180-day periods during which only the debtor may file and solicit acceptances to the debtor’s plan. The court may grant requests for extensions of time of the exclusive periods for “cause”. While extensions of the exclusivity period still require a showing of “cause”, under amended Section 1121(d), the exclusivity period cannot be extended beyond the aforementioned 18-month and 20-month deadlines for filing and soliciting approval of a debtor’s plan.

Small Business Provisions

Statistics have shown that a small business cannot survive a Chapter 11 bankruptcy proceeding unless that small business is able to get in and out of the bankruptcy court within a reasonable period of time.

Section 431 – Flexible Rules for Disclosure Statement and Plan
Section 431 modifies Section 1125(a)(1) of the Bankruptcy Code by making certain steps easier for small business cases. This is accomplished by ensuring that when the bankruptcy court considers a debtor’s disclosure statement, it must take into account the complexity of the case, the benefit of additional information to creditors and other parties in interest, and the cost associated with providing any additional information (This also applies in all other Chapter 11s). This section also allows the bankruptcy court to dispense with the requirement of a disclosure statement altogether in cases in which: (i) the debtor is classified as a small business and; (ii) when the debtor’s plan itself provides enough adequate information. In a small business case, a court can approve a disclosure statement that has been submitted on standard forms approved by the court or adopted under 28 U.S.C. 2075.

Section 432 – Definitions
Defines a “small business debtor” as one engaged in commercial or business activities that has aggregate non-insider, non-affiliate, non-contingent liquidated secured and unsecured debts, as of the date of the commencement of the bankruptcy, of not more than $2 million, provided there is no active creditors’ committee.

Section 433 – Standard Form Disclosure Statement and Plan
It is the intent of the legislation that an official form disclosure statement and plan of reorganization for small business debtors will be created to achieve a practical balance between:

(i) the reasonable needs of the courts, the United States Trustee, creditors, and other parties in interest for reasonably complete information; and

(ii) economy and simplicity for debtors.

Section 434 – Uniform National Reporting Requirements
Adds a new Bankruptcy Code Section 308, instituting supplemental reporting requirements for small business debtors. A small business debtor will now be required to file periodic financial and other reports containing information that includes: (i) the debtor’s profitability; (ii) the debtor’s projected cash receipts and disbursements over a reasonable period; and (iii) comparisons of actual cash receipts and disbursements with projections in prior reports. The small business debtor must also state in the report whether it is in compliance with all applicable bankruptcy laws and whether it is timely filing tax returns and required government filings. Additionally, the small business debtor must report if it is timely paying taxes and other administrative expenses when due.

If the small business debtor is not timely making required government filings and/or not making tax and other administrative payments when due, the debtor must report what the failures are and how, at what cost, and when the debtor intends to remedy such failures. The effective date of this provision is 60 days after the date of promulgation of the Bankruptcy Rules required under this provision.

Section 436 – Duties in Small Business Cases
The legislation mandates additional duties for a debtor and a trustee. It remains to be seen whether or not these new duties will result in an orderly use of the Small Business provisions of the legislation or whether the additional duties will, in and of themselves, become a burden that cannot be fulfilled. The additional requirements for a debtor are that:

(i) the most recent balance sheet, statement of operations, cash-flow statement and federal income tax return must be filed with a voluntary Chapter 11 petition. Alternatively, a statement under penalty of perjury must be filed stating that no balance sheet, statement of operations, or cash-flow statement has been prepared and no federal income tax return has been filed;
(ii) the debtor must attend meetings scheduled by the court or the United States Trustee, including the initial debtor interview, the meeting of creditors, and scheduling conferences, unless the court, after notice and hearing, waives this requirement;
(iii) the debtor timely file all schedules and statements of financial affairs, unless the court grants an extension of not more than 30 days, absent extraordinary and compelling circumstances;
(iv) the debtor file all postpetition financial and other reports required by the Bankruptcy Rules or local rules;
(v) the debtor maintain insurance customary and appropriate to the debtor’s industry;
(vi) the debtor timely file tax returns and other required government filings;
(vii) the debtor timely pay all taxes except those being appropriately contested; and
(viii) the debtor allow the United States Trustee, or a designated representative to inspect the debtor’s premises, books and records at reasonable times and upon reasonable notice.

Section 437 – Plan Filing and Confirmation Deadlines
Modifies Section 1121(e) regarding the period of time for a small business debtor to file and confirm a plan. It provides that a small business debtor has the exclusive right to file a plan for the first 180 days following the order for relief. This period may be extended after a notice of hearing if: (i) the debtor demonstrates by a preponderance of the evidence that it is more likely than not that the court will confirm a plan within a reasonable period of time; (ii) a new deadline is imposed at the time the extension is granted; and (iii) the order extending the time is signed before expiration of the existing deadline. Alternatively, the 180-day period may be extended if the court so orders “for cause”, an easier standard. The amendment further requires that a small business debtor must file a plan and a disclosure statement (if any) within 300 days of the order for relief, subject to extension only if the small business debtor satisfies the tougher requirements contained in (i), (ii) and (iii) above. The passage of these deadlines would result in the debtor’s inability to confirm a plan and be grounds for conversion of the case to Chapter 7 or dismissal.

Under existing law, a small business may elect to be considered a small business. There is no such election provision under the amended Section 1121(e). Under existing law, only the debtor may file a plan for the first 100 days following the date of the commencement of the bankruptcy case and all plans must be filed within 160 days of the date of commencement of the bankruptcy case. The 100-day and 160-day time periods may be reduced by the court, for cause, upon the request of a party in interest made within the respective periods. The court may increase the 100-day exclusive period if the debtor shows that the need for an increase was caused by circumstances for which the debtor should not be held accountable.

Section 438 – Plan Confirmation Deadline
Modifies Section 1129 by requiring that the court confirm a plan in a small business case not later than 45 days from the date the plan is filed, provided the plan complies with all applicable provisions of the Bankruptcy Code. This 45-day period may only be extended if: (i) the debtor demonstrates by a preponderance of the evidence that it is more likely than not that the court will confirm a plan within a reasonable period of time; (ii) a new deadline is imposed at the time the extension is granted; and (iii) the order extending the time is signed before the existing deadline expires.

This is a new subsection to Section 1129. Under current law there is no provision that specifically provides a deadline for plan confirmation in a small business case.

Section 441 – Serial Filer Provisions
Modifies the automatic stay provisions of Bankruptcy Code Section 362 to limit damage awards to actual damages (i.e., not punitive damages) for willful violation of the automatic stay, when such violation is based on an action taken by an entity with the good faith belief that Section 362(h) (as amended, involving individual debtors and matters relating to the debtor’s statement of intention) applies.

In addition, Section 441 of the new legislation amends Bankruptcy Code Section 362 by adding a new subsection (n), applicable only to small business cases. The amendment provides the automatic stay does not apply in a case in which the debtor: (i) is a debtor in a small business case; (ii) was a debtor in a small business case that was dismissed by an order that became final in the two-year period ending on the commencement of the current bankruptcy case; (iii) was a debtor in a small business case in which a plan was confirmed in the two-year period ending on the commencement date of the current bankruptcy case; or (iv) is an entity that acquired substantially all the assets or business of a small business debtor described in (i) through (iii), above, unless the entity can establish that it acquired substantially all of such assets or such business in good faith.

However, the new subsection (n) does not apply to an involuntary bankruptcy filing where there was no collusion between the debtor and petitioning creditors, or where the debtor can prove: (i) the filing of the petition resulted from circumstances beyond the control of the debtor not foreseeable at the time the case then pending was filed; and (ii) it is more likely than not that the court will confirm a feasible plan, but not a liquidating plan, within a reasonable period of time.

Leases And Executory Contracts

Section 309(b) – Personal Property Leases
Amends Bankruptcy Code Section 365 by adding a new subparagraph (p), which automatically terminates the automatic stay with respect to a lease of personal property that is rejected or not timely assumed by the debtor under Bankruptcy Code Section 365(d).

For individuals filing Chapter 7 cases, the debtor may notify the creditor, in writing, that the debtor intends to assume the lease of personal property. The creditor may, at its option, notify the debtor that the creditor is willing to have the lease assumed and may condition the assumption on the cure of any outstanding default by the terms set forth in the lease contract.

For cases under Chapter 11 where the debtor is an individual (and in Chapter 13 cases), if the debtor is a lessee of personal property and the lease is not assumed by the plan, then the lease is deemed rejected at the conclusion of the confirmation hearing.

Section 328 – Defaults Based on Nonmonetary Obligations
Modifies Section 365 by providing that a debtor need not cure a nonmonetary default arising from a debtor’s failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure the default by performing such nonmonetary acts at and after the time of assumption. However, if a default arises from the debtor’s failure to operate in accordance with a nonresidential real property lease, the default must be cured by performance at and after assumption in accordance with the lease, and pecuniary losses from such default must be compensated in accordance with Section 365(b)(1).

The amendment further provides that a debtor’s obligation to cure defaults under an assumed lease does not apply to a debtor’s breach of a penalty provision relating to a default arising from the debtor’s failure to perform nonmonetary obligations under an executory contract or lease.

The amendment also modifies Section 1124(2)(a) to allow as “unimpaired”, for plan purposes, claims that meet the requirements above regarding nonmonetary defaults (i.e., where such nonmonetary defaults do not have to be cured). A claim that arises by reason of a debtor’s failure to perform a nonmonetary obligation, other than a default arising from the breach of nonresidential real property lease, is impaired unless the creditor is compensated for any actual pecuniary loss arising from such failure.

The amendment also makes technical amendments to Section 365 by deleting provisions relating to aircraft leases, which are no longer effective.

Section 404 – Executory Contracts and Unexpired Leases
Modifies Section 365(d)(4) to provide that a debtor must assume or reject an unexpired lease of nonresidential real property by the earlier of: (i) 120 days from the date of the order for relief; or (ii) the date of confirmation of a plan. The debtor’s failure to assume or reject a lease by such date will result in the lease being deemed rejected. A court may extend the deadline set forth above for up to one additional 90-day period, upon motion of the debtor or lessor, for cause shown. Such extension must be granted prior to the expiration of the original 120-day period. The court may only grant subsequent extensions upon the prior written consent of the lessor for each such extension.

Under existing law, a debtor has 60 days from the commencement of the bankruptcy to assume or reject a nonresidential real property lease. This 60-day period can be extended for cause, giving the court virtually carte blanche power to grant multiple extensions. If the debtor does not assume or reject such lease within the initial 60-day or any extended period, the lease will be deemed rejected. There is currently no outside limit on the amount of time the initial 60-day period can be extended or how many extensions a bankruptcy court may grant. Moreover, under current law, the court may grant an extension of time for a debtor to assume or reject a lease over the objection of lessor. It has become common practice in large Chapter 11 cases for a court to extend the debtor’s time to assume or reject a nonresidential real property lease until the confirmation of a plan. Accordingly, this amendment greatly expands a lessor’s ability to force a debtor to decide early in a case whether to assume or reject commercial leases by denying the court any discretion to extend the debtor’s time to assume or reject the lease after the maximum 210-day period, without the lessor’s written consent.

In addition, this amendment modifies Section 365(f)(1) to clarify that in order for a debtor to assign a contract or lease under Section 365, the debtor must comply with the assumption requirements under Section 365(b), such as complying with use clauses where a lease of real property in a shopping center is assumed or assigned.

Section 445 – Priority for Administrative Expenses
Modifies Section 503(b) to add a new Section 503(b)(7) that contains a new administrative expense claim related to a nonresidential real property lease that is assumed under Section 365 and subsequently rejected. The amount of the allowed administrative claim arising from the debtor’s rejection of a previously assumed nonresidential real property lease is equal to all monetary obligations due (excluding those relating to failure to operate or a penalty provision) for a period of two years following the later of: (i) the rejection date; or (ii) the date of actual turnover of the premises. Such claim cannot be subject to reduction or setoff for any reason, except for amounts actually received or to be received from a nondebtor entity. The lessor’s claim for the balance of rejection damages beyond this two-year period will be treated as a general unsecured claim subject to the cap contained in Section 502(b)(6).

This is a new provision. Under existing Section 365(g)(2), all sums due under an assumed lease could be granted an administrative priority status.

Bankruptcy Abuse

Section 308 – Reduction of Homestead Exemption for Fraud
The intent of an individual debtor is to obtain a discharge of its debt. This has always been known as the “fresh start” obtained by the filing of a bankruptcy petition. Bankruptcy Code Section 522 is the section of the Code which provides specific exemptions for assets belonging to individuals. Corporate credit grantors may wonder how individual exemption changes relate to corporate bankruptcies. Among the many changes which the amendment will cause regarding individual debtors, a substantial number of those changes will relate to individuals who have participated in fraud, not so much in individual conduct, but as it relates to corporate fraud. In recent years, the courts have found many individuals employed by large corporations receive unwarranted sums as retirement packages. Then a bankruptcy petition is filed and the individual is able to protect those retirement funds from creditor attack. The amendment will modify those exemptions by placing restrictions on the ability of an individual debtor to obtain a discharge if that individual debtor has been involved in fraud.

First, the amendment specifically adds another type of property which may be exempt. Retirement funds which an individual may exempt has been broadened and clarified. A simple definition of those retirement funds now exempt are those funds contained “in a fund or account that is exempt from taxation under Section 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code of 1096.”

This addition to the available exemptions is particularly interesting in light of the recent decision by the United States Supreme Court finding that certain retirement accounts are exempt from the claims of one’s creditors. The amendment will effectively codify what the Supreme Court has just determined to be proper. This will put to rest split decisions among the courts. There is substantial expansive language as to what retirement funds are now exempt.

The amendment also expands the type of property which may be claimed by a debtor as a homestead exemption under current law. Bankruptcy Code Section 522 (d) is modified to include as property which may be claimed as a homestead and exempted as such, the following:

The Bankruptcy Code is modified to provide that each of these exemptions will be reduced to the extent the value of any such exempt property is attributable to all or any portion of any property which the debtor may have disposed of in the 10-year period ending on the date of the filing of the petition “with the intent to hinder, delay, or defraud a creditor” and that the debtor could not have exempted when it disposed of the property.

Section 310 – Limitation on Luxury Goods
The Bankruptcy Code is modified to provide specific limits for assets of a debtor which are deemed to be luxury goods. Luxury goods which are now presumed to be nondischargeable include:
(I) consumer debts owed to a single creditor and aggregating more than $500 for luxury goods or services incurred by an individual debtor on or within 90 days before the order for relief under this title;
(II) cash advances aggregating more than $750 that are extensions of consumer credit under an open-end credit plan obtained by an individual debtor on or within 70 days before the order for relief under this title.

Section 312 – Extension of Period Between Bankruptcy Discharges
The period of time which must pass before a Chapter 7 debtor can be granted a subsequent discharge is increased from six years to eight years.

Section 322 – Limitations on Homestead Exemption
A debtor will still have the ability to choose state or local law exemptions rather than federal exemptions when filing its Chapter 7 petition. Nevertheless, for those debtors choosing state exemptions, Section 522 of the Bankruptcy Code is modified to state:

“…a debtor may not exempt any amount of interest that was acquired by the debtor during the 1215-day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 in value in—

(A) real or personal property that the debtor or a dependent of the debtor uses as a residence;
(B) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence;
(C) a burial plot for the debtor or a dependent of the debtor; or
(D) real or personal property that the debtor or dependent of the debtor claims as a homestead.”

This limitation does not apply to a family farmer for the principal residence of such farmer.

Further, this limitation does not apply to any interest of the debtor in a prior principal place of residence (acquired prior to the 1215-day period) which is transferred into the current principal place of residence of the debtor.

If a debtor chooses its local or state law exemptions which may be more expansive than the federal exemptions, the Bankruptcy Code is modified so that a debtor may not claim more than $125,000 as a homestead exemption if:

(A) the court determines, after notice and a hearing, that the debtor has been convicted of a felony (as defined in Section 3156 of Title 18), which under the circumstances, demonstrates that the filing of the case was an abuse of the provisions of this title; or

(B) the debtor owes a debt arising from—

Section 331 – Limitation on Retention Bonuses, Severance Pay, and Certain Other Payments
Modifies Section 503 to restrict the circumstances under which transfers may be made to, or for the benefit of, an insider of the debtor in order to induce such insider to remain with the debtor’s business. The amendment requires that, prior to such transfer being allowed or paid, the court must find: (i) the transfer is essential to retention because the insider has a bona fide job offer from another business (at the same or greater compensation rate); (ii) the services of the insider are essential to the survival of the business; and (iii) either:

(x)the transfer is not greater than 10 times the amount of a similar transfer given to non-management employees during the calendar year in which the transfer is made or obligation is incurred; or

(y)if no such non-management transfers were made, the amount of the transfer to the insider is not more than 25 percent of any similar transfer or obligations given during the calendar year prior to the year in which the transfer is made or obligation is incurred.

The amendment further modifies Section 503 by disallowing severance payments to an insider unless: (i) the severance payment is part of a program generally applicable to all full-time employees; and (ii) the severance amount is not more than 10 times the amount of mean severance pay given to non-management employees during the calendar year in which this payment is made.

The amendment further prohibits any other transfers or obligations to insiders that are outside the ordinary course of business and not justified by the circumstances of the case (including transfers to officers, managers or consultants hired after the date of the commencement of the bankruptcy case).

Section 1402 – Fraudulent Transfers and Obligations
Section 1402 of the Act amends Section 548 by enabling the trustee the recovery of avoidable transfers and excessive pre-petition compensation, such as bonuses, paid to insiders of a debtor. It effectuates two changes to current law that would make it easier for a trustee to avoid pre-petition transfers. First, Section 1402(1) extends the one-year reach-back period for fraudulent transfers to two years. Second, Section 1402(2) amends Bankruptcy Code Section 548(a) to clarify that it permits the recovery of any transfer to, or an obligation incurred for the benefit of an insider under an employment contract, under certain conditions.

Section 1402 further modifies Section 548 by adding a new subparagraph (e) to allow a debtor to use its Chapter 5 avoidance powers to avoid any transfer of an interest of the debtor in property that was made within 10 years of the date of commencement of the bankruptcy case if the: (i) transfer was made to a self-settled trust or similar device; (ii) transfer was made by the debtor; (iii) debtor was a beneficiary of the trust; and (iv) debtor made the transfer with actual intent to hinder, delay or defraud a present or future creditor. The amendment clarifies that a transfer avoidable by this new subsection includes transfers in anticipation of a money judgment, settlement, civil penalty or fine for violation of securities laws, regulations or order, or in connection with the purchase or sale of a security under specified provisions of federal security laws.

Section 1405 – Appointment of Trustee in Cases of Suspected Fraud
Modifies Section 1104 by adding a new subsection (e) that requires the United States Trustee to make a motion for the appointment of a trustee in a Chapter 11 case if there are reasonable grounds to suspect that:

(i) current members of the debtor’s governing body;
(ii) the debtor’s CEO or CFO; or
(iii) the members of the governing body who selected the debtor’s CEO or CFO

participated in actual fraud, dishonesty or criminal conduct in the management of the debtor or the debtor’s public financial reporting.

Effective Date Of Statute

Sections 1406 and 1501 of the amendment address the effective date of the legislation.

Generally, the effective date of the additions and amendments made to the Bankruptcy Code by the legislation is 180 days after the date of enactment of the Act. The date of enactment is, of course, the date on which it is signed into law by the President of the United States. President Bush has signed the legislation.

Generally, there is no retroactive effect of Section 1501 of the amendment. Therefore, virtually all additions and amendments to the Bankruptcy Code only impact those cases filed on or after the date of enactment.

There are some exceptions to the general effective date of the statute, a few of which are of interest to commercial credit grantors.

Section 1234 – Involuntary Cases
Modifies Section 303 to define eligibility requirements for a creditor to qualify to file an involuntary bankruptcy petition. The amendment provides that for cases in which there are more than 12 creditors of the potential debtor, where three or more creditors may file an involuntary petition, each such creditor must hold a claim that is not contingent as to liability and not the subject of a bona fide dispute “as to liability or amount.” Such “noncontingent, undisputed” claims must total at least $12,300 more than any liens securing such claims. The amendment changes existing law by requiring such claims to be undisputed, noncontingent, and not subject to bona fide dispute as to liability or amount.

This amendment takes effect on the date of enactment of the new legislation and applies to all cases commenced before, on or after the enactment date. Significantly, this will retroactively apply to pending involuntary cases.

Miscellaneous

Section 232 – Consumer Privacy Ombudsman
Over the last several years, there has been an increased concern that a sale of assets of a debtor could have a negative impact on consumers. This issue began to emerge as proprietary lists of customers became a popular asset of a debtor which could be sold at great value. Many of the issues have surrounded the privacy rights of an individual to have its personal information remain private.

The Bankruptcy Code is now modified to add a provision for the appointment and compensation of a consumer privacy ombudsman when a hearing is to be held on a sale or lease of debtor’s assets which could impact these privacy rights.

The ombudsman may appear at the hearing and will be expected to provide the court with information to assist the court in its determination of whether or not to approve a sale of assets. The information to be provided to the court will generally describe the facts, circumstances and conditions of the proposed sale or lease of this personally identifiable property. It is anticipated that the report of the ombudsman will include the following type of data:

It is important to note that the personally identifiable information which is obtained by the ombudsman shall not be disclosed. The impact that this change will have on commercial grantors remains to be seen. However, it is the hope that this modification will enable Chapter 11 debtors to sell or lease their property without contested battles in the court because of the protections which will be provided by this consumer privacy ombudsman.

Section 315 – Giving Creditors Fair Notice in Chapter 7 and 13 Cases
Modifies Bankruptcy Code Section 342 to significantly expand the noticing obligations that a debtor has to its creditors. It requires that, if within 90 days of the commencement of the bankruptcy case, a creditor supplies the debtor—in at least two communications sent to the debtor—with the current account number of the debtor and the address at which such creditor requests to receive such correspondence, then any notice the debtor may be required to send to such creditor must be sent to such address and include such account number.

For Chapter 7 and Chapter 13 cases, where the debtor is an individual, a creditor may at any time both file with the court and serve on the debtor a notice of address to be used to provide notice to the creditor in the case.

A monetary penalty may not be imposed on a creditor for a violation of the automatic stay provisions of Section 362(a) unless the conduct that is the basis for such violation occurs after the creditor receives notice in accordance with the procedures outlined above.

Section 315 of the new legislation also modifies Section 521 by adding a new subparagraph (e), which requires an individual debtor in a Chapter 7 or Chapter 13 case to provide to the trustee (not later than seven days prior to the first meeting of creditors) a copy of the debtor’s federal income tax return for the most recent tax year ending immediately before the commencement of the bankruptcy case and for which a federal income tax return was filed. The debtor is also required to simultaneously provide copies of such tax returns to any creditor that makes a timely request of the debtor. The debtor, at the request of the court, United States Trustee or any party in interest, must also provide copies of federal tax returns and amendments filed with the taxing authority that were not filed for the three-year period preceding the order for relief.

In Chapter 13s, there is also an expanded disclosure requirement concerning a debtor’s income and expenditures in the prior tax year and the debtor’s monthly income.

Section 319 – Sense of Congress Regarding Expansion of Rule 9011 of the Federal Rules of Bankruptcy Procedure
Not a specific amendment, but instead expresses the sense of Congress that Bankruptcy Rule 9011 should be modified to require all documents (including schedules), signed and unsigned, submitted to the court or to a trustee, by pro se debtors and debtors represented by attorneys, be submitted only after a debtor or its attorney makes reasonable inquiry to verify that information in such document is:

(i) well grounded in fact; and
(ii) warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law.

Section 413 – Creditor Representation at First Meeting of Creditors
Modifies Section 341(c) to provide that a creditor holding a consumer debt (or any representative of the creditor) is permitted to appear at or participate in the meeting of creditors in a case under Chapter 7 or Chapter 11, either alone or in conjunction with an attorney for such creditor. This provision applies notwithstanding any local rule or applicable nonbankruptcy law or other requirement that representation at a meeting of creditors be by an attorney. The amendment clarifies that nothing in Section 341(c), as modified, shall be construed to require any creditor to be represented by an attorney at any meeting of creditors.

Ancillary And Other Cross-Border Cases

Sections 801 and 802 create a new Chapter 15 of the Bankruptcy Code to address issues concerning multinational bankruptcy cases. The new Chapter 15 incorporates the Model Law on Cross-Border Insolvency, which was promulgated by the United Nations, to provide mechanisms to deal with cross-border insolvency. Chapter 15 is intended to establish cooperation between United States’ courts, trustees and debtors and their foreign counterparts. It also prescribes guidelines for: (i) access of foreign representatives and creditors to federal and state courts; (ii) recognition of a foreign proceeding and relief; (iii) cooperation and communication with foreign courts and representatives; and (iv) concurrent proceedings and the coordination of foreign and domestic proceedings. As a result of this change, more foreign companies might utilize the United States Bankruptcy Courts.

Ms. Borges and Mr. Nathan would like to acknowledge the contributions of Scott Cargill of Lowenstein Sandler, PC in the preparation of this article.

Wanda Borges, Esq. is a member of the firm Borges & Associates, LLC. She can be reached via e-mail at borgeslawfirm@aol.com.

Bruce S. Nathan, Esq. is a Partner in the law firm of Lowenstein Sandler PC in New York, NY. He is also a member of NACM and the American Bankruptcy Institute. He can be reached via e-mail at bnathan@lowenstein.com.

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