California Business Bankruptcy Blog

Economic Downturn (Recession?) Subject of ABA Journal Survey

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 18 Nov 2008 10:59:12 -0800

Greetings from the trenches. As the economy has slowed down, business has picked up for those of us in the insolvency world. Just like many of you, this has kept me busy and unable to attend to the blog as I wish. But I came out of my hole to let you know about a survey being conducted by the ABA Journal.

Effects of the Wall Street crisis have spanned the country, and the ABA Journal is surveying lawyers for their thoughts on the economy. Please take this brief 2-minute survey.

Survey results will be published in the January ABA Journal. Answers will be kept confidential and used only in combination with all other responses received.

Take the time to add your input.

Nearly One Million Bankruptcy Cases Filed in Last 12 Months

tegland@kleinlaw.com (Terrence T. Egland) — Thu, 28 Aug 2008 11:44:27 -0800

According to data released by the Administrative Office of the U.S. Courts, and discussed in the Los Angeles Times, nearly one million bankruptcy cases were filed between July 1, 2007, and June 30, 2008--a total of 967,831 cases. That represents a 28.9% increase over the preceding 12 month period. And, as discussed on the ABI web site, based on that same data, bankruptcy filings have increased 29.2% in the first half of 2008 relative to the same time period in 2007.

Leading the way in bankruptcy filings is the Ninth Circuit, in particular California. Filings in the Ninth Circuit increased by a staggering 60.9%. This is, of course, no surprise given the catastrophic impact that the real estate downturn has had on the California economy over the last year and a half.

Nationally, Chapter 7 filings increased by 36.7%, Chapter 13 grew by 16.9%, Chapter 11 increased by 30.6%, and Chapter 12 filings actually decreased by 18.7% when compared to the prior 12 months.

As steep as the increases appear, the total number of filings still has a long way to go to match the total amount of filings of even two years ago, as revealed by the Administrative Office's data. For example, take a look at this spread sheet. In the period July 1, 2005 through June 30, 2006, the total number of filings was nearly 1.5 million. Data shows that the years prior to 2006 had similar amounts of cases initiated.

Therefore, although the new data indicates a steep incline, the aggregate filings are still below historical levels.

May decline in home prices worst ever

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 29 Jul 2008 13:51:29 -0800

Making headlines today is the release of the Standard & Poors/Case-Shiller Home Price Indices. According to this index, there was a nationwide decline of 15.8% in home values in May when compared to the same time last year. In Los Angeles, as noted by the Los Angeles Times, the decline is much more distressing:

The Los Angeles area saw a 24.5% May price decline from a year ago and also hit a record low annual decrease.

As many of you remember, we endured a real estate downturn in the early to mid nineties that resulted in a similar percentage decline, but with a major difference:

The Los Angeles decline from the peak now matches the 1990's real estate downturn, but has occurred in less than two years. In the previous real estate cycle, Los Angeles area prices declined more gradually, falling 27% from 1990 to 1996 before stabilizing, according to the Case-Shiller index.

What does the rapid decline mean to the bankruptcy world? With the present decline compressed to a period of only two years, versus seven years in the nineties, it seems inevitable that the volume consumer bankruptcy filings will increase--as has already happened--as families come under increasing financial pressure. This pressure is on all fronts as the price of consumer goods increases and families do not have the fall back reserves of equity that they would usually rely on.

But commercial bankruptcy is also becoming more prevalent as the real estate and oil price woes are impacting sole proprietorships and closely held businesses, along with the headline-making corporate bankruptcies. Chapter 11 filings in the first quarter of 2008 were up 61.5% over the same period in 2007 (200 in 2008 and 123 in 2007). While not historically record breaking when compared to the 1990s, the quantity of Chapter 11 filings indicates an upward trend that may only now be catching up with the declining economic conditions of the country.

If you would like to go deeper into the home price data, access the historical data for this index at the Standard & Poor's website.

Bits, Bytes, and Potential Pitfalls: E-Discovery Continued

tegland@kleinlaw.com (Terrence T. Egland) — Mon, 07 Jul 2008 14:47:29 -0800

I am back! As most bankruptcy practitioners already know, the volume of work has increased. This has lead to an ever increasing scarcity of free-time to devote to the blog. Important topics, however, need to be discussed so I soldier on.

In that vein, today is part two of my discussion regarding electronic discovery and its impact on the bankruptcy practitioner. Part one covered what electronically stored information (“ESI”) is generally, and why a bankruptcy practitioner should care. Part two covers some of the nuts and bolts needed in order to manage the handling of ESI.

Know how your client’s ESI is handled

In order to serve your client properly, a bankruptcy practitioner faced with discovery of ESI must know how the ESI is created, stored, and preserved. In essence, you must know who to talk to: the Information Technology (“IT”) professionals.

The first item of information that you will need to request from your client’s IT professionals is a detailed “map” of the client’s computer network. Click here for an example of a simple computer network. As you can see from the example, such a map provides information on all of the end users and the equipment used by everyone in the organization. This information is vital when it comes time to physically search the network for relevant information.

When looking at your particular client’s network map, it is also important to take note of the physical layout of the network, i.e., is it in one location (a local area network or "LAN," or maintained in multiple geographic locations in a city, state, or U.S., a wide area network or ("WAN"). The scope, and as a result, the cost, of the information gathering process will be impacted by the geographic location of the network, and could be a factor in filing for a protective order based on the burden of the search.

Under Federal Rules of Civil Procedure Rule 34(a), the constituent parts of an organization’s overall computer network include not only its LAN or WAN, off-site storage and back-up, and individual computers, it also includes all peripheral devices such as printers, scanners, flash drives, cell phones, and personal digital assistants ("PDAs"), etc.

Apart from the network map, it is also important to get a copy of the organization chart of the IT department so that you can speak directly to the people who will know where the information you need is hiding. Here is an example of an IT department organizational chart from Seton Hall University. As you can see from the example, an IT department could be quite vast and speaking to only one person in IT may not cut it.

Ideally, the people in the IT organization chart should have a firm grasp on the organization’s document retention policy (discussed in part one). This means that they will know in detail the dates of deletion and back-up for all of the organizations data.

Once you have a handle on your own organization’s ESI (something that should occur long before any actual litigation is initiated), you should turn your attention to the opposing parties’ ESI and the discovery necessary to obtain it. The same basic information discussed above is required to do a thorough job, i.e., network map and IT organization chart. A copy of the document retention policy and use policy of the opposing organization is also essential. All of these documents should be identified in the litigation hold letter that you will immediately send to opposing counsel (see part one).

Next time I will discuss the format of the ESI you should request and the 500 lb. gorilla in this conversation: cost.

Vallejo Becomes Largest City in California to File Chapter 9

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 27 May 2008 13:25:57 -0800

It's now official: Vallejo is now the largest city in California to file for Chapter 9 protection. Long believed to be in the works, the bay area city filed in the U.S. Bankruptcy Court for the Eastern District of Californiat in Sacramento last Friday [update: Case No. 08-26813; petition and schedules available through PACER]. As described in the San Francisco Chronicle,

This Bay Area suburb of about 120,000 people faces a $16 million deficit in its fiscal year starting July 1. Bankruptcy will keep services running and prevent creditors from suing the city while officials devise a plan to get back on solid financial footing.

Like Vallejo, many U.S. cities are saddled with labor contracts that offer salaries, overtime pay, pensions and health benefits they say they can't afford. Those expenses are expected to balloon as health care costs soar and employees retire earlier and live longer.

Vallejo officials hope the bankruptcy judge will allow the city to rewrite its labor contracts and bring compensation down. If they're successful, other cities may follow their lead, experts say.

As one city official put it, "Vallejo has been spending beyond its means for more than 15 years," said J.D. Miller, a financial planner and longtime Vallejo resident who served on the budget committee. "We've acted like someone who lives their life and spends their money as if their job will always be there."

As the budget crisis takes further hold of California, can other cities be far behind Vallejo?

The Subprime Spread

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 22 Apr 2008 09:51:09 -0800

As the subprime crisis deepens and grows and the potential for recession increases, the effects are seeping into other industries as consumers are tightening their belts in order to afford food and gas. Michael Barbaro of the New York Times discussed the effects on retailers in a recent article:

Since last fall, eight mostly midsize chains — as diverse as the furniture store Levitz and the electronics seller Sharper Image — have filed for bankruptcy protection as they staggered under mounting debt and declining sales.

But the troubles are quickly spreading to bigger national companies, like Linens ‘n Things, the bedding and furniture retailer with 500 stores in 47 states. It may file for bankruptcy as early as this week, according to people briefed on the matter.

Even retailers that can avoid bankruptcy are shutting down stores to preserve cash through what could be a long economic downturn. Over the next year, Foot Locker said it would close 140 stores, Ann Taylor will start to shutter 117, and the jeweler Zales will close 100.

The surging cost of necessities has led to a national belt-tightening among consumers. Figures released on Monday showed that spending on food and gasoline is crowding out other purchases, leaving people with less to spend on furniture, clothing and electronics. Consequently, chains specializing in those goods are proving vulnerable.

Our own insolvency practice here in Bakersfield has felt the impact of this upsurge in bankruptcy filings generally, and retailers in particular. Recently the firm has filed two new Chapter 11 cases with another ready in the next week or so (an incredible rate for a relatively small market). It appears that the window for bankruptcy attorneys to take a vacation has passed and the ramp up for coping with increased case loads must shift into high gear as more and more regional retailers enter the "zone of insolvency" and seek the help of a bankruptcy professional.

E-Filing is Serious Business

tegland@kleinlaw.com (Terrence T. Egland) — Mon, 21 Apr 2008 08:56:18 -0800

Failure, or in this case refusal, to file bankruptcy cases electronically can jeopardize your bar card. The Kansas Supreme Court has suspended an attorney for, in part, refusing to e-file bankruptcy cases for three clients:

The Kansas Supreme Court held that the lawyer, Stephen D. Harris, violated his duty to represent his clients with competence, diligence and promptness. The court ordered a suspension because of the e-filing problem as well as a second complaint that he mishandled a civil case, Legal Blog Watch reports.

New rules took effect in September 2004 requiring all bankruptcy pleadings to be filed electronically. But the lawyer didn’t comply and tried to file a case the old-fashioned way four months later, Legal Blog Watch reports, citing a report on the Legal Profession Blog.

The bankruptcy court ordered the lawyer to obtain training and a login for electronic filing in the next 30 days, but he didn’t comply, the Kansas Supreme Court said in its March 28 opinion. Instead he tried to file a second case by paper pleadings and received yet another warning. A third client who was unhappy with the lawyer’s failure to e-file for him filed a disciplinary complaint. Harris did not return the complaining client's $800 advance fee, the court said.

The full opinion of the Kansas Supreme Court can be found by clicking here.

Bankruptcy Lawyers in Demand

tegland@kleinlaw.com (Terrence T. Egland) — Fri, 11 Apr 2008 11:06:04 -0800

As if the increase in filings under all chapter of the bankruptcy code and the heavy workload we are all experiencing weren't enough evidence of the demand for competent bankruptcy counsel, a new survey conducted by a recruiting firm and discussed in the ABA Journal confirms that fact:

A new survey has found that lawyers expect bankruptcy to be the hottest growth area for law firms this year. That’s no secret to law firm managers who are already beefing up bankruptcy practices.

One out of four lawyers surveyed said the fastest area of growth would be in bankruptcy work, exceeding the number who designated corporate governance and litigation as the sectors most likely to see increases, the Wall Street Journal reports. More than 300 lawyers from large law firms responded to the survey by Robert Half Legal.

Managers at two law firms told the newspaper they are already adding more lawyers to their bankruptcy and restructuring departments.

Gregory Milmoe, the co-leader of the corporate restructuring department at Skadden, Arps, Slate Meagher & Flom in New York City, said demand for bankruptcy services at his firm has “emphatically increased.” His group has increased by 17 lawyers and he expects three more will be added over the next two months. In January and February, the department billed 45 percent more hours than the same period last year.

Marshall Huebner, who co-chairs the bankruptcy group at Davis Polk & Wardwell, said his lawyers are “extremely busy.” The firm cross-trains lawyers and has moved 15 of them from banking and litigation work over to the bankruptcy department.

The survey results are good news for lawyers with three to five years of experience in bankruptcy practice who want to move to a new job, said Charles Volkert, executive director of Robert Half Legal.

"Hands-on experience really matters,” he told the Wall Street Journal. “Legal professionals who are able to demonstrate a proven track record in that area are in demand."

Now more than ever is a great time for bankruptcy practitioners. Keep on truckin'!

Bits, Bytes, and Potential Pitfalls: What All Lawyers Need to Know about Electronically Stored Information

tegland@kleinlaw.com (Terrence T. Egland) — Fri, 11 Apr 2008 09:24:47 -0800

After a hectic few weeks of actual law practice, I am back in the blog saddle once again. This time I want to discuss an issue that, although not strictly speaking a bankruptcy issue, significantly impacts the practice of all bankruptcy professionals: electronic discovery. I will address this issue in a series of posts giving you what I think are the most important things for the bankruptcy professional to initially understand about the handling and production of electronically stored information.

As of December 1, 2006, the Federal Rules of Civil Procedure amendments dealing with electronic discovery went into effect. Those Rules, of course, are incorporated into the Federal Rules of Bankruptcy Procedure. In today’s world of computers, networks, and electronic storage of information, the impact that those technologies have on management of information, and potentially the marshaling of evidence for litigation, is huge. The amendment of the Rules is the judiciary’s first attempt at trying to address these mediums outside conflicting court decisions.

What is Electronically Stored Information?

First, it is important to know what it is we are talking about. So, what is Electronically Stored Information? Electronically Stored Information (“ESI”) is any electronic data stored on various media types:

It exists in our computers, computer peripherals (like printers and fax machines), PDAs, as well as pagers and wireless phones.
It also resides in storage on disks, back-up tapes or removable drives, CDs, and other forms of media.
It also exists in a great deal of hidden data in areas such as “metadata,” system data, and deleted data seemingly overwritten.

One important question related to the definition of ESI that is unanswered by the Rules or case law is this: are web-based e-mail programs (e.g., Hotmail, AOL, etc.) used by employees ESI of their employer? In other words, would your client, the client’s employee, or the email provider, have to provide the contents of the email account if the employee accessed it at work, even though the account is ostensibly the employee’s private account? Is it the employer's ESI at that point? If you have an answer to this question I would love to hear from you via a comment to this post.

Why is ESI relevant to my bankruptcy practice?

ESI is relevant to all bankruptcy practitioners because it raises issues involving preservation, production, and privilege. In that regard, it is relevant to litigation, transactional, business counseling, and reorganization practice:

Under the new rules, and in general, any competent business planning and counseling attorney must take into account the client's system for managing, storing, and disposing of ESI. In the old days, firms would keep paper files that, if bulky, were easy to store and made the locating of relevant information fairly easy. But today, with the advent of electronic means of storage, the ability to find relevant information is only as good as the planning and implementation of a logical storage system.

In this vein, it is essential for all business counseling and reorganization attorneys to make sure their clients have updated and current Document Retention Policies. This document makes explicit a firm's policies and procedures regarding the storage and, importantly, the scheduled destruction of data. It is vital, as the Rules allow, to implement a reasonable scheduled destruction policy. Even more important, however, than the creation of a Policy, is making sure the firm actually FOLLOWS the Policy. The provision for proper handling and destruction of documents is of little use if the organization doesn't use it.

Related to that, it is important for any business to have a written policy governing the use of company ESI. The policy must address employees’ personal use of company email and whether employees at work may use web-based e-mail. This is important to prevent transmission of information out of the company in unplanned ways. It also must make clear that the company maintains ownership of ESI. The policy should also state that there is no employee expectation of privacy

Once a bankruptcy petition is filed, and the preference litigation eventually ensues, the above described policies come into play. Any bankruptcy practitioner knows that the filing of a bankruptcy petition, if not in existence already, will lead to litigation. As a result, bankruptcy practitioners have a duty to inform their client's to preserve any and all ESI in anticipation of that litigation. This is prudent, because if competent counsel is representing the creditors or, if appointed, the trustee a Litigation Hold letter will arrive instructing you to do just that. Conversely, you may find yourself in the position of issuing a Litigation Hold letter that instructs the other side of their duty to preserve ESI. In any event, it is crucial that ESI is considered from the start, especially when dealing with large entities, to prevent lengthy discovery battles and the spoliation of evidence.

ESI poses a serious threat to the attorney-client and the work product privilege. Ordinarily, when ESI is produced it is not completely vetted to cull out any privileged information. The Rules provide for this situation by providing for a "clawback" agreement between the parties that requires the return of any privileged information produced. But, in reality the bell cannot be unrung and the better approach is to not produce privileged information in the first place. This can be more easily managed if a detailed and logical document retention policy is implemented, aiding in the search of ESI.

Next time I will address more in depth the duties of an attorney with regard to ESI and the Rules themselves. Stay tuned.

"I would have a preference for cash." Who doesn't?

tegland@kleinlaw.com (Terrence T. Egland) — Wed, 27 Feb 2008 10:20:19 -0800

When given the choice between accepting millions of dollars in cash or an "equivalent" value of stock in a bankrupt corporation, which would you choose? If you said cash, then you are in agreement with the former CEO and current chairman of Delphi. That corporation's plan of reorganization is being scrutinized by the New York Bankruptcy Court in Manhattan and provides Steve Miller an $8.3 million "emergence" from chapter 11 bonus. In total, the plan provides $87 million in emergence bonuses to executives.

The IUE-CWA union objected to the provision on the grounds that it was too high and as part of a proposed settlement of the objection asked if Miller would accept stock in lieu of cash. In answering Miller stated that "I decided I would accept it as cash. I would have a preference for cash." "So would the creditors," was the union's lawyer's response. More on this story can be found here.

How could Delphi expect that such exorbitant bonuses would not be questioned? Does an executive really deserve a bonus for leading a bankrupt organization out of Chapter 11; especially when he was the one at the helm when it entered bankruptcy? The union obviously doesn't think so, considering that Delphi may have $8.65 billion in financing for operations going forward out of bankruptcy is the $8.3 million to the former CEO of any significant consequence other than emotionally? I would say probably not. Rarely is the compensation for executives subject to review by union or others, however, so the bankruptcy proceeding provides the perfect opportunity for the union and its lawyers to shine a spotlight on executive compensation and question its merit. I can't say that I blame them.

Increase in Consumer BK Volume Should Lead to Increased Chapter 11 Filings

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 05 Feb 2008 09:41:37 -0800

There is an interesting statistical tid-bit posted on the American Bankruptcy Institute web site today concerning the increase in consumer bankruptcy filings and their connection to the sub prime mortgage crisis:

U.S. consumer bankruptcy filings increased more than 30 percent nationwide in January from the same period a year ago, according to the ABI relying on data from the National Bankruptcy Research Center (NBKRC). While the consumer filings for January increased from the previous year, the data showed that the overall January consumer filing totals were flat from December. Chapter 13 filings constituted 40.05 percent of all consumer cases in January, a slight increase over December. “With over one million more subprime adjustable-rate mortgages due to reset during 2008, the payment shock for many households could lead to higher bankruptcies this year,” said ABI Executive Director Samuel J. Gerdano. The overall consumer filing total for the 2007 calendar year (Jan. 1 – Dec. 31, 2007) reached 801,840, nearly a 40 percent increase from the 573,203 filings recorded during the similar period in 2006. Click here to view the updated monthly consumer filing charts.

With consumer cases building in volume, it is logical to conclude that Chapter 11 filings will increase, especially for businesses involved in residential construction and mortgage lenders. One example of the fallout from the mortgage debacle also appears on the ABI web site just below the above story:

New Century Financial Corp. and its creditors filed a chapter 11 plan yesterday that does not say how the company plans to pay creditors who have filed $35 billion in claims against it, the Associated Press reported yesterday. Once one of the country's largest subprime lenders, New Century raised only about $235 million by selling assets in its bankruptcy liquidation, according to documents filed Saturday in the U.S. Bankruptcy Court in Wilmington, Del. New Century's chapter 11 plan said that negotiations are underway that could cut the amount of claims filed in the case. Creditors filed $23.7 billion in secured claims and $10.5 billion in unsecured claims. Read more.

Another example of sub prime mortgage related failures is the Chapter 11 filing on friday of Wickes Furniture as noted in the Chicago Tribune:

Wickes Furniture Co., hit by the downturn that has hit furniture retailers in the wake of the housing industry's big slump, filed Sunday for Chapter 11 bankruptcy protection.

Wickes, based in Wheeling, is owned by Sun Capital Partners Inc., a Boca Raton investment firm that specializes in leveraged buyouts and other transactions.

In its filing with the federal bankruptcy court in Wilmington, Del., Wickes declared that it has assets of between $10 million and $50 million, and estimated its liabilities at between $50 million and $100 million.

The trade magazine Furniture Today reported in mid-January that Wickes Furniture was asking suppliers to sign an agreement that would postpone the company's repayment of overdue debt until mid-2009.

When viewing these sub prime mortgage related bankruptcy news items, one can't help but get the feeling that this is just the tip of the iceberg. Things could be become very busy very fast for all reorganization professionals.

Chapter 12 Bankruptcy Part IV: The Discharge

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 08 Jan 2008 10:13:56 -0800

Welcome back and Happy New Year! After a short break it is nice to be back at the keyboard. This is the fourth and final installment in the Chapter 12 Tutorial: the discharge.

After completing all payments under the chapter 12 plan, the debtor will receive a discharge as long as the debtor certifies that all domestic support obligations, if any, have been paid. What is a discharge? The discharge is the whole point. The discharge has the effect of freeing the debtor, with limited exceptions, from all debts provided for by the plan, allowed under section 503, or disallowed under section 502. Your creditors who were provided for under the plan, whether in full or in part, may no longer seek repayment from you regarding the discharged debts. The slate is wiped clean.

Certain categories of debts are not discharged in chapter 12 proceedings. 11 U.S.C. § 1228(a). Those categories include:

debts for willful and malicious injury to person or property;
debts for death or personal injury caused by the debtor’s operation of a motor vehicle while the debtor was intoxicated; and
debts from fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny.

The bankruptcy law regarding the scope of a chapter 12 discharge is complex, however, and debtors should consult competent legal counsel in this regard prior to filing. Those debts which will not be discharged should be paid in full under a plan. With respect to secured obligations, those debts may be paid beyond the end of the plan payment period under a separate agreement and, accordingly, are not discharged.

But what if you cannot make your plan payments, can you still get a discharge? The court may grant a “hardship discharge” to a chapter 12 debtor even though the debtor has failed to complete plan payments. 11 U.S.C. § 1228(b). Generally, a hardship discharge is available only to a debtor whose failure to complete plan payments is due to circumstances beyond the debtor’s control and through no fault of the debtor. Creditors must have received at least as much as they would have received in a chapter 7 liquidation case, and the debtor must be unable to modify the plan. For example, injury or illness that precludes employment sufficient to fund even a modified plan may serve as the basis for a hardship discharge. The hardship discharge does not apply to any debts that are nondischargeable in a chapter 7 case, 11 U.S.C. § 523.

Chapter 12 Tutorial Part III: The Chapter 12 Plan

tegland@kleinlaw.com (Terrence T. Egland) — Mon, 17 Dec 2007 13:10:05 -0800

A Chapter 12 debtor must file a repayment plan no later than 90 days after the petition date unless the court grants an extension due to circumstances "for which the debtor should not justly be held accountable." 11 U.S.C. § 1221. The plan provides for payments of fixed amounts to the trustee on a regular basis and must be approved by the Court. The trustee then distributes the funds to creditors according to the terms of the plan, which typically pays creditors some amount less than 100 cents on the dollar.

There are three types of claims that must be provided for in the plan:

Creditors holding priority claims are granted special status by the bankruptcy law, such as claims for back taxes, domestice support obligations, such as child support, and the costs of the bankruptcy proceeding, including the fees of the attorneys and the trustee. 11 U.S.C. § 507;
Secured claims are those for which the creditor has the right to liquidate certain property if the debtor does not pay the underlying debt, such as loans given secured by real property or equipment; and
Unsecured claims are generally those for which the creditor has no special rights to collect against particular property owned by the debtor.

A chapter 12 plan usually provides for a three or, if the Court allows, five year repayment period. The plan must provide for full payment of all priority claims except for three exceptions:

if the claim is owed to a governmental unit arising out of the sale or disposition of a farm asset used in the farm operation, in which case the claim is treated as unsecured;
If a priority creditor agrees to different treatment of the claim; or
in the case of a domestic support obligation, unless the debtor contributes all “disposable income” – discussed below – to a five-year plan. 11 U.S.C. § 1222(a)(2)(A) and (B), (4).

Secured creditors must be paid at least as much as the value of the property used to secure the debt. An interesting aspect of Chapter 12 bankruptcy is that payments to secured creditors can sometimes continue longer than the three-to-five-year period of the plan. For example, if the debtor’s underlying debt was scheduled for payment over more than five years (i.e., an equipment loan or a mortgage), the debtor may be able to pay the loan off over the original loan repayment schedule as long as any arrearage is made up during the plan.

The plan does not have to pay unsecured claims in full as long as it commits all of the debtor’s projected “disposable income” (or property of equivalent value) to plan payments over a 3 to 5 year period, and as long as the unsecured creditors are to receive at least as much as they would receive if the debtor’s nonexempt assets were liquidated under chapter 7. 11 U.S.C. § 1225. “Disposable income” is defined as income not reasonably necessary for the maintenance or support of the debtor or dependents or for making payments needed to continue, preserve, and operate the debtor’s business. 11 U.S.C. § 1225(b)(2).

Within 45 days of filing the plan, the presiding bankruptcy judge decides at a “confirmation hearing” whether the plan is feasible and meets the standards for confirmation under the Bankruptcy Code. 11 U.S.C. §§ 1224, 1225. Creditors, who receive 20 days’ notice, may appear at the hearing and object to confirmation. Fed. R. Bankr. P. 2002(a)(8). While a variety of objections may be made, the typical arguments are that payments offered under the plan are less than creditors would receive if the debtor’s assets were liquidated, or that the plan does not commit all of the debtor’s disposable income for the period of the plan.

If the court confirms the plan, the chapter 12 trustee will distribute funds received in accordance with the terms of the plan. 11 U.S.C. § 1226(a). If the court does not confirm the plan, the debtor may file a modified plan. 11 U.S.C. § 1223. The debtor may also convert the case to a liquidation under chapter 7. 11 U.S.C. § 1208(a). If the debtor fails to confirm a plan and the case is dismissed, the court may authorize the trustee to keep some of the funds for costs, but the trustee must return all remaining funds to the debtor (other than funds already disbursed to creditors). 11 U.S.C. § 1226(a).

On occasion, changed circumstances will affect the debtor’s ability to make plan payments. A creditor may object or threaten to object to a plan, or the debtor may inadvertently have failed to list all creditors. In such instances, the plan may be modified either before or after confirmation. 11 U.S.C. §§ 1223, 1229. Modification after confirmation is not limited to an initiative by the debtor, but may also be made at the request of the trustee or an unsecured creditor. 11 U.S.C. § 1229(a).

The provisions of a confirmed plan bind the debtor and each creditor. 11 U.S.C. § 1227. The debtor must make the plan succeed once the court confirms the plan. The debtor must make regular payments to the trustee, which will require adjustment to living on a fixed budget for a prolonged period. Furthermore, while confirmation of the plan entitles the debtor to retain property as long as payments are made, the debtor may not incur any significant new debt without consulting the trustee This is because additional debt may compromise the debtor’s ability to complete the plan. 11 U.S.C. §§ 1222(a)(1), 1227. In any event, failure to make the plan payments may result in dismissal of the case. 11 U.S.C. § 1208(c). In addition, the court may dismiss the case or convert the case to a liquidation case under chapter 7 of the Bankruptcy Code upon showing that the debtor has committed fraud in connection with the case. 11 U.S.C. § 1208(d).

Next time in Part IV, I discuss the discharge under Chapter 12 of the Bankruptcy Code.

Chapter 12 Tutorial Part II: How Chapter 12 Works

tegland@kleinlaw.com (Terrence T. Egland) — Fri, 07 Dec 2007 11:48:31 -0800

A bankruptcy case under chapter 12 begins with the filing of a petition in the bankruptcy court (1) with jurisdiction over the area where the individual lives or (2) in the jurisdiction where the corporation or partnership debtor has its principal place of business or principal assets. Unless the court orders otherwise, the debtor must also file:

schedules of assets and liabilities,
a schedule of current income and expenditures,
a schedule of executory contracts and unexpired leases, and
a statement of financial affairs.

Fed. R. Bankr. P. 1007(b); In the Eastern District of California also see Local Rule 1007-1. A married couple may file jointly or as individuals. 11 U.S.C. § 302(a). (The Official Forms may be downloaded here. They are not available from the court.)

Under current law, and in the Eastern District of California, the courts must charge a $200.00 case filing fee and a $39.00 miscellaneous administrative fee for the filing of a Chapter 12 petition. Normally these fees are paid to the clerk of the court when the petition is filed, but, with the court’s permission, they may be paid in installments. 28 U.S.C. § 1930(a); Fed. R. Bankr. P. 1006(b). The number of payment is limited to four and the debtor must make the final installment within 120 days of filing. Fed. R. Bankr. P. 1006(b). The court may extend the time of any installment for cause, which can extend the due date an additional 60 days for a total of 180 days. Id. If a joint petition is filed, only one filing fee and one administrative fee are charged. Debtors should be aware that failure to pay these fees may result in dismissal of the case. 11 U.S.C. § 1208(c)(2).

In order to complete the Official Bankruptcy Forms which make up the petition, statement of financial affairs, and schedules, the debtor will need to gather up the following information:

A list of all creditors and the amounts and nature of their claims;
The source, amount, and frequency of the debtor’s income;
A list of all of the debtor’s property; and
A detailed list of the debtor’s monthly farming and living expenses, i.e., food, shelter, utilities, taxes, transportation, medicine, feed, fertilizer, etc.

Married filers must gather this information for each spouse regardless of whether they are filing a joint petition, separate individual petitions, or even if only one spouse is filing. In a situation where only one spouse files, the income and expenses of the non-filing spouse are required so that the court, the trustee, and the creditors can evaluate the household’s financial position.

A trustee is appointed to administer the case once a chapter 12 petition is filed. 11 U.S.C. § 1202. In some districts, the U.S. trustee appoints a standing trustee to serve in all chapter 12 cases. 28 U.S.C. § 586(b). As in chapter 13, the trustee both evaluates the case and serves as a disbursing agent, collecting payments from the debtor and making distributions to creditors. 11 U.S.C. § 1202.

Filing the petition under chapter 12 “automatically stays” (stops) most collection actions against the debtor or the debtor’s property. 11 U.S.C. § 362. Along with the discharge, discussed in a forthcoming post, the stay is one of the prime benefits of filing a bankruptcy petition. Filing the petition does not, however, stay certain types of actions listed under 11 U.S.C. § 362(b), such as criminal proceedings and judgments in existence before filing. The stay arises by operation of law and requires no judicial action. As long as the stay is in effect, creditors generally cannot initiate or continue any lawsuits, wage garnishments, or even telephone calls demanding payments. The bankruptcy clerk gives notice of the bankruptcy case to all creditors whose names and addresses are provided by the debtor, so accurate and full disclosure of all outstanding debts is essential and to every debtor's benefit.

Chapter 12 also contains a special automatic stay provision that protects co-debtors. A creditor may not seek to collect a “consumer debt” from any individual who is liable with the debtor without bankruptcy court approval. 11 U.S.C. § 1201(a). Consumer debts are individual debts acquired for a personal, family, or household purpose. 11 U.S.C. § 101(8).

Between 20 to 35 days after the petition is filed, the chapter 12 trustee will hold a “meeting of creditors,” commonly referred to as the "341 meeting" due to its origins in 11 U.S.C. § 341 of the bankruptcy code. If the U.S. trustee or bankruptcy administrator schedules the meeting at a place that does not have regular U.S. trustee or bankruptcy administrator staffing, the meeting must be held within 60 days of filing. During the 341 meeting, the trustee puts the debtor under oath and both the trustee and creditors may ask questions. The debtor must attend the meeting and answer questions regarding the debtor’s finances and the proposed terms of the debtor’s repayment plan. 11 U.S.C. § 343; Fed. R. Bankr. P. 4002. If a husband and wife have filed a joint petition, they both must attend the 341 meeting. In order to preserve their independent judgment, bankruptcy judges are prohibited from attending. 11 U.S.C. § 341(c). The parties typically resolve problems with the plan either during or shortly after the 341 meeting. Generally, the debtor can avoid problems by making sure that the petition and plan are complete and accurate, and by consulting with the trustee prior to the meeting.

To participate in distributions from the bankruptcy estate in a Chapter 12 case, unsecured creditors must file their claims with the court within 90 days after the first date set for the meeting of creditors. Fed. R. Bankr. P. 3002(c). A governmental unit, typically the IRS or state taxing agency, however, has 180 days from the date of filing to file a proof of claim. 11 U.S.C. § 502(b)(9).

After the 341 meeting, the debtor, the chapter 12 trustee, and interested creditors will attend a hearing on confirmation of the debtor’s chapter 12 repayment plan.

Next time I will discuss the Chapter 12 plan and its confirmation by the court.

Important Amendments to the Federal Rules of Bankruptcy Procedure

tegland@kleinlaw.com (Terrence T. Egland) — Mon, 03 Dec 2007 15:50:16 -0800

Amendments to the Federal Rules of Bankruptcy Procedure went into effect on December 1st, 2007. Omnibus objections to multiple claims, changes to cash collateral and DIP financing stipulations, and restrictions on first day motions are among the changes. Bob Eisenbach of the In the (Red) blog has posted a concise and easily understandable explanation of the key changes here. I suggest you read it lest ye forget to batten down an open hatch.

Chapter 12 Tutorial Part I: Background

tegland@kleinlaw.com (Terrence T. Egland) — Fri, 30 Nov 2007 09:33:38 -0800

Today is Part I in a four part series of posts discussing the basics of family farmer or family fisherman bankruptcy under Chapter 12 of the bankrutpcy code. Today I provide some background on Chapter 12.

Chapter 12 is designed for “family farmers” or “family fishermen” with “regular annual income.” It enables financially distressed family farmers and fishermen to propose and carry out a plan to repay all or part of their repayment plan to make installments to creditors over three to five years. Generally, three years unless the court approves a longer period “for cause.” But unless the plan proposes to pay 100% of domestic support claims (i.e., child support and alimony) if any exist, it must be for five years and must include all the debtor’s disposable income. In no case may a plan provide for payments over a period longer than five years. 11 U.S.C. § 1222(b)-(c).

In tailoring bankruptcy law to meet the economic realities of family farming and the family fisherman,

chapter 12 eliminates many of the barriers such debtors would face if seeking to reorganize under either chapter 11 or 13 of the Bankruptcy Code. For example, chapter 12 is more streamlined, less complicated, and less expensive than chapter 11, which is better suited to large corporate reorganizations. In addition, few family farmers or fishermen find chapter 13 to be useful because it is designed for wage earners who have smaller debts than those facing family farmers. In chapter 12, Congress sought to combine the features of the Bankruptcy Code that can provide a framework for successful family farmer and fisherman reorganizations.

The Bankruptcy Code provides that only a family farmer or family fisherman with “regular annual income” may file a petition for relief under chapter 12. 11 U.S.C. §§ 101(18), 101(19A), 109(f). The purpose of this requirement is to ensure that the debtor’s annual income is sufficiently stable and regular to permit the debtor to make payments under a chapter 12 plan. But chapter 12 makes allowance for situations in which family farmers or fishermen have income that is seasonal in nature. Relief under chapter 12 is voluntary, and only the debtor may file a petition under the chapter.

Under the Bankruptcy Code, “family farmers” and “family fishermen” fall into two categories: (1) an individual or individual and spouse and (2) a corporation or partnership. Farmers or fishermen falling into the first category must meet each of the following four criteria as of the date the petition is filed in order to qualify for relief under chapter 12:

The individual or husband and wife must be engaged in a farming operation or a commercial fishing operation.
The total debts (secured and unsecured) of the operation must not exceed $3,237,000.00 (if a farming operation) or $1,500,000.00 (if a commercial fishing operation).
If a family farmer, at least 50%, and if family fisherman at least 80%, of the total debts that are fixed in amount (exclusive of debt for the debtor’s home) must be related to the farming or commercial fishing operation.
More than 50% of the gross income of the individual or the husband and wife for the preceding tax year (or, for family farmers only, for each of the 2^nd and 3^rd prior tax years) must have come from the farming or commercial fishing operation.

In order for a corporation or partnership to fall within the second category of debtors eligible to file as family farmers or family fishermen, the corporation or partnership must meet each of the following criteria as of the date of the filing of the petition:

More than one-half the outstanding stock or equity in the corporation or partnership must be owned by one family or by one family and its relatives.
The family or the family and its relatives must conduct the farming or commercial fishing operation.
More than 80% of the value of the corporation or partnership assets must be related to the farming or fishing operation.
The total indebtedness of the corporation or partnership must not exceed $3,237,000.00 (if a farming operation) or $1,500,000.00 (if a commercial fishing operation).
At least 50% for a farming operation or 80% for a fishing operation of the corporation’s or partnership’s total debts which are fixed in amount (exclusive of debt for one home occupied by a shareholder) must be related to the farming or fishing operation.
If the corporation issues stock, the stock cannot be publicly traded.

A debtor cannot file under chapter 12 (or any other chapter) if during the preceding 180 days a prior bankruptcy petition was dismissed due to the debtor’s willful failure to appear before the court or comply with orders of the court or was voluntarily dismissed after creditors sought relief from the bankruptcy court to recover property upon which they hold liens. 11 U.S.C. §§ 109(g), 362(d) and (e). In addition, no individual may be a debtor under chapter 12 or any chapter of the Bankruptcy Code unless he or she has, within 180 days before filing, received credit counseling from an approved credit counseling agency either in an individual or group briefing. 11 U.S.C. §§ 109, 111. There are exceptions in emergency situations or where the U.S. trustee (or bankruptcy administrator in North Carolina or Alabama) has determined that there are insufficient approved agencies to provide the required counseling. If a debt management plan is developed during required credit counseling, it must be filed with the court.

Law Firm Faces Another Conflict Accusation Due to Non-Disclosure

tegland@kleinlaw.com (Terrence T. Egland) — Wed, 14 Nov 2007 09:56:26 -0800

Practitioners in the bankruptcy world are accustomed to dealing with representations that in other practice areas might be construed as a conflict of interest. For example, a law firm may represent a Chapter 7 trustee in a consumer bankruptcy case and at the same time represent a creditor in a case where that same Chapter 7 Trustee, an attorney in his own right, represents the debtor. Similarly, there may be times when a firm represents both the Trustee and a creditor in the same bankruptcy with an appropriately limited scope of representation of the Trustee. With such arrangements commonplace, it is important for bankruptcy practitioners to still remain vigilant regarding any potential conflicts hiding in the underbrush, especially when dealing with issues of non-disclosure.

SonicBlue, the creator of the Rio MP3 player, filed under Chapter 11 in the Northern District of California, and its attorneys, Pilsbury Winthrop, have created two separate issues for itself. "In March, U.S. Bankruptcy Judge Marilyn Morgan of San Jose, Calif., disqualified Pillsbury, citing a 'complete breakdown of creditor confidence' after the firm failed to disclose that it had been threatened with a lawsuit by some of the creditors." Now, Pilsbury has been accused of another damaging non-disclosure that created a conflict with its client:

On Tuesday, McGrane and other lawyers for a claims trader -- SonicBlue Claims, created to buy creditors' claims against the failed electronics maker -- accused Pillsbury in a court filing of not disclosing a tolling agreement between the firm and directors and officers of its client SonicBlue. The agreement, extending the statute of limitations on a potential malpractice claim, stems from a dispute over insurance. The board blamed Pillsbury for its insurance company's refusal to pay directors' and officers' coverage for a suit filed against SonicBlue by some note holders.

"Disputes have arisen as to whether Pillsbury is liable to the directors for damages that may have been incurred by the directors as a result of the coverage denial," reads the agreement, dated Aug. 18, 2006. Lawyers for the claims trader -- from Los Angeles' Stutman Treister & Glatt and San Francisco's McGrane Greenfield -- argue that the dispute and the subsequent tolling agreement gave Pillsbury conflicting motivations in handling claims against the board. The claims trader says the situation should've been disclosed to the court. (read the full law.com article here)

In the first instance, Pilsbury lost the business of representing SonicBlue in the case, and thus its presumable large revenue stream. Now, if the accusation comes to anything, Pilsbury stands to lose money in the form of damages for losses to the corporation due to the directors actions. Yikes.

It is important for bankruptcy counsel to always bear in mind the competing constituencies involved in every bankruptcy proceeding. What may be a good idea in garden variety civil litigation, may be a devastating decision in the bankruptcy arena. Deals with clients in business litigation such as that between Pilsbury and the SonicBlue board may be perfectly reasonable in most situations, but in bankruptcy, where the interests of creditors are paramount in a debtor-in-possession situation, such a deal undermines the entire process because Pilsbury could not be expected to fully pursue claims against the board if Pilsbury was potentially on the hook for any damages by agreement. Being able to recognize hidden conflicts as well as the obvious ones is essential to a successful bankruptcy practice, as the SonicBlue representation highlights.

Light at the End of the Tunnel

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 30 Oct 2007 11:41:10 -0800

Lionel Model Trains has reached a tentative deal with Mike's Train House Electric Trains ("MTH") to settle their long-running dispute over Lionel's use of MTH trade secrets, including a system for simulating smoke in toy steam engines. MTH successfully sued Lionel and the $38.6 million dollar judgment it received forced Lionel into Chapter 11. The agreement now reached between the two could potentially lead to Lionel successfully exiting Chapter 11 by the first quarter of 2008. The Wall Street Journal notes that the deal is not yet final:

"Lionel and MTH have entered into the MTH settlement agreement, which resolves all MTH claims, including the patent-infringement claim, and all pending litigation between the parties," Lionel said.

Mike Wolf, founder of MTH, cautioned that the settlement, which is contingent on Lionel raising new financing to fund its reorganization plan, among other requirements, could still be derailed.
. . .
"It's not a done deal, even though the monetary part has been finalized," he said. "It could still blow apart."

Mr. Wolf and Lionel Chief Executive Jerry Calabrese each declined to disclose the terms of the settlement. But in court papers, MTH has said the only thing holding up a settlement was a spat over the future use of certain model-train technologies.

Although MTH doesn't enjoy Lionel's brand recognition, the smaller company believes it has superior technology.

Mr. Calabrese, however, believes the settlement resolves all MTH claims and pending litigation between the companies.

"I'm not going to contradict Mike, but my understanding is that all issues have been settled and the only contingency is exiting bankruptcy," he said.

The plight of Lionel, the much larger rival of MTH, illustrates the fragility of even the most durable and long-lasting corporations. Lionel has been in business for 107 years and one lawsuit chased it into Chapter 11 because it could not absorb that large of a judgment.

This case also highlights the need to maintain ethical standards in the face of market pressure. Whether Lionel felt that its size and name recognition insulated it from such a suit (arrogance) or the use of its rival's technology was due to the immense pressure it felt to maintain its position in the market (fear), its conduct points to the need for management to maintain vigilance regarding a compay's ethical duties-in this case swiping a rivals ideas and incorporating them into your product.

Is Chinese Investment in a U.S. Bank a Good Thing?

tegland@kleinlaw.com (Terrence T. Egland) — Tue, 23 Oct 2007 11:36:41 -0800

The prominent bankruptcy and reorganization law firm of Shearman & Sterling recently announced the following on its web site:

Beijing, 8 October 2007—Shearman & Sterling has advised China Minsheng Bank (“Minsheng”) on its investment in UCBH Holdings, Inc. (“UCBH”) (NASDAQ: UCBH) the holding company of United Commercial Bank. This transaction marks the first Mainland Chinese bank to successfully make a strategic investment in a U.S bank.

Under the terms of the agreement and subject to regulatory approvals, Minsheng will acquire an aggregate 9.9% ownership interest in UCBH, with a mutual option to increase the ownership to 20% by 2009 in two phases. In the first phase, which is anticipated to close in the fourth quarter of 2007, UCBH will issue approximately 5.4 million shares of its common stock to Minsheng, following which, Minsheng will own 4.9% of UCBH.

More on this story can be read here and here.

The Boston Globe noted that "[t]he deal may herald a string of strategic investments by cash-flush Chinese financial firms in the United States and the rest of the world in coming months and years . . . ." This begs the question: Is this a good thing or a bad thing? The United States Treasury Secretary believes that it is a good thing:

WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson on Tuesday said that foreign investment in the United States by China or any other government was a good thing and had always been a feature of the country's open economy.

"I very much welcome investment in our country by all foreign nations, including China," Paulson told a conference on U.S.-China relations in answer to a question.

Paulson hosted a dinner for sovereign wealth funds on Friday in Washington after a meeting of Group of Seven industrialized powers in order to improve the dialogue with these government-controlled investment funds, and he found nothing sinister in their motives.

"From everything I could see, the intent and the practices of either all or the vast majority (of sovereign wealth funds)...were economically driven," he said.

With money switching directions and coming into the United States from China, rather than the other way around, Chinese investment in the U.S. has the potential of lessening the ridiculously large trade deficit between the U.S. and China. On the other hand, pundits have warned that Chinese investment in U.S. markets could threaten U.S. security. In fact, there is a committee within the Treasury Department specifically tasked with analyzing the national security threat of any potential Foreign Direct Investment: The Committee on Foreign Investments in the United States.

To bring this post in line with its stated purpose, to discuss bankruptcy issues, the increase in foreign investment in U.S. industries heightens the possibility that any Chapter 11 will have an international flavor--with creditors filing claims from around the world. Only this last month KDG represented a potentially insolvent client that was subject to commercial arbitration in Hamburg, Germany, with a European supplier of a Chinese product. Bankruptcy professionals must be prepared to represent clients in an international marketplace. I am proud to work for such a firm.

Data Shows Chapter 11 Reorganization Results in Greater Return than Market Sale

tegland@kleinlaw.com (Terrence T. Egland) — Mon, 22 Oct 2007 21:49:13 -0800

"Conventional" wisdom holds, especially in the United States, that a free market economy is always preferable to regulation. The most obvious proponents of this view are the members of the Chicago School of economics, members of which have advocated the replacement of Chapter 11 reorganization with market sales to recapture a struggling business's "going concern" value, or in the alternaive, an outright elimination of Chapter 11 and making Chapter 7 liquidiation mandatory. In sum, the ability to recapture going concern value on the open market, it is argued, renders bankruptcy reorganization obsolete.

To challenge the momentum of this school of thought, professor Lynn M. LoPucki and Joseph W. Doherty of the UCLA School of Law conducted an empirical study "comparing the recoveries in bankruptcy sales of large public companies in the period 2000-2004 with the recoveries in bankruptcy reorganizations during the same period." Their findings are in the article Bankrutcy Fire Sales published in 106 Michigan Law Review 1 (2007). The author's data shows that "recoveries in reorganization cases are more than double the recoveries from going concern sales":

We found that the companies sold for an average of 35% of reported value, but reorganized for an average fresh-start value of 80% of reported value and an average market capitalization value of 91% of reported value. After logging these ratios (to reduce the effect of outliers) and controlling for the lower earnings (EBITDA) of the sold companies we estimated the market capitalization reorganization recoveries at 75% of reported value and sale recoveries at 29% of reported value. In essence, our data showed that the recovery from reorganizing a large, public company was, on average, more than double the recovery from selling an apparently identical company.

If reliable, the data from the last few years flies in the face of "conventional" wisdom and reaffirms the viability of Chapter 11 reorganization as a tool to help rehabilitate a financially struggling, yet potentially profitable, corporation.

Now, professor LoPucki and one of his chief academic adversaries, professor Douglas Baird of the University of Chicago, are battling it out over this topic on the University of Chicago Faculty Blog. Here is link to the first post.