Standing on the Edge

As a threshold matter, there is a question of whether it is even permissible to file these cases. Some judges have been heard to say that they will not allow their courtrooms to be used to liquidate secured creditors' collateral. However, most courts do allow it ' the Bankruptcy Code does not prohibit a Chapter 11 simply because its primary beneficiaries will be secured creditors. Many judges, however, condition these cases on the provision of a carve-out for professional fees. These judges consider it the 'price of admission' secured creditors must pay in order to obtain the substantial benefits of Chapter 11 (Perhaps the most famous statement of this point of view is contained in an open letter Bankruptcy Judge Peter J. Walsh wrote to members of the Delaware bankruptcy bar on April 2, 1998).

Carve-Outs

Professional fee carve-outs are common features in bankruptcy cases. Without a carve-out to assure payment, other creditors could find themselves funding professional fees that are incurred primarily to benefit secured creditors. Moreover, professionals would bear the risk that a case will be successful enough to enable payment. We have argued with success in certain cases that the section 506(c) rationale supporting professional fee carve-outs is equally applicable to support carve-outs for other administrative creditors (Section 506(c) authorizes a debtor-in-possession (or trustee) to 'recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim').

The apex of a debtor's leverage to make these arguments, of course, is before a case is filed. While a carve-out is not a panacea because it will always be subject to a negotiated budget, a disciplined approach toward cost-control during a case is in any event essential.

General Cost Saving Measures

An estate's costs can be reduced with straightforward measures such as shopping for reduced rates on copying, teleconference, and other services. These are simple, but often neglected points. Appropriate venue selection can also keep administrative costs down because of varying judicial views on the administrative status of certain claims. For example, the First and Third Circuits consider the post-petition portion of severance pay for post-petition termination of 'rank-and-file' employees to be an administrative expense, while the Second Circuit generally accords the entirety of such severance claims administrative priority. (See, Roger Higgins, Severance Pay and the Termination of Employees During Bankruptcy, The Bankruptcy Strategist, July 2002). A similar circuit split exists between the Third and Seventh Circuits regarding unpaid taxes accrued pre-petition but billed post-petition by landlords.

More creative cost saving can be utilized in appropriate situations as well. For example, we recently saved hundreds of thousands of dollars in copying and mailing costs by serving a 'short form disclosure statement' (about a dozen pages) on all creditors entitled to vote on a plan instead of the several-hundred-page plan and disclosure statement that was made available only to those creditors who requested it after receiving the short form. While the Bankruptcy Code does not specifically authorize a short-form disclosure statement, neither is it prohibited. (Bankruptcy Rule 3017(d)(1) requires the distribution of 'the plan or a court-approved summary of the plan.' The Rule makes no mention of a disclosure statement summary.) Moreover, a shorter document may be easier to read and understand, especially where information is being delivered to large numbers of relatively unsophisticated creditors, such as customers.

Confirm As Early As Possible

One of the most effective ways to minimize costs of a Chapter 11 case is to end it by confirming a Chapter 11 plan as expediently as possible. A key drawback to Chapter 11 is the inherent redundancy of the process. Multiple sets of professionals (representing the interests of the debtors, creditors, as well as other parties) must often be borne by the estate. In addition, if a debtor can demonstrate that it can be depended on to protect the interests of unsecured creditors, it may be able to effectively argue against the appointment of counsel for an unsecured creditors committee, another cost-saving result. If a committee is appropriate, however, a good relationship with committee counsel can be crucial to running an efficient estate.

While fees and other expenses associated with a Chapter 11 case are, to some extent, unavoidable, they can be minimized by seeking confirmation as early in the process as possible. Early confirmation may be achieved by diligent work and sensible compromises on potentially contentious issues as early in the case as possible. Confirmation, however, usually requires a debtor to have enough cash to pay all accrued administrative expenses and priority claims near the date of confirmation of the Chapter 11 plan. This is not always feasible. To overcome this obstacle, in appropriate circumstances, a delayed effective date may be appropriate.

Delayed Effective Date

When a debtor can prove it will have sufficient funds to effectuate the distributions called for under its plan at a certain future date, but will not possess those funds at or shortly after confirmation (perhaps due to the delay in selling a piece of property or in collecting on avoidance actions or insurance payments), the debtor may attempt to confirm a plan that delays the effective date until such funds will be available, even if such a period is months after confirmation.

A delayed effective date allows a post-confirmation estate to come into existence more quickly, thus eliminating (or at least greatly reducing) the redundancy of the Chapter 11 process. Similarly, the need to go to court may be reduced in post-confirmation settings, as authority is often transferred from a court-supervised debtor-in-possession to a trust controlled by trustees.

Case law is sparse on this topic and we have only attempted this route (with success) once. The Code does not define the term 'effective date.' In In re Rolling Green Country Club, 26 B.R. 729, 734-35 (Bankr. D. Minn. 1982), the court upheld an effective date tied to the accumulation of fund necessary to make certain payments required under the plan. The court in In re Inter Urban Broadcasting of Cincinnati, Inc., Case No. 94-2382-83, 1994 WL 646176 (E.D. La. Nov. 16, 1994) took a similar approach, upholding an effective date that was the date a radio station was sold, and was later redefined to be a date no later than 15 days after FCC approval of a license agreement or the date the confirmation became final. However, in In re Potomac Iron Works, 217 B.R. 170 (Bankr. D. Md. 1997), the court held that a 1-year delay between entry of the confirmation order and the effective date was unreasonable. (It should be noted that in its decision, the Potomac court inaccurately quotes the court in In re Rolling Green County Club, and incorrectly characterizes the holding of the Rolling Green court as disallowing a delayed effective date.) In Potomac, the feasibility of the plan depended on the successful collection of accounts receivable that were owed to the Debtor. Various parties, including local taxing authorities, objected to the Plan, questioning the collectability of the accounts receivable. Because there is no per se prohibition against a delayed effective date, we think the issue is most appropriately examined under the lens of a feasibility analysis if the equities of the case warrant it and if supported by creditors.

Chapter 5 Causes of Action

A secured creditor may take the position that it has a lien against any proceeds from Chapter 5 causes of action, such as recoveries of preferences. While, a secured creditor's lien on substantially all of the debtor's assets might include such proceeds, the analysis should not end there. A debtor has a persuasive argument that the secured creditor should not be entitled to a lien on the proceeds of such litigation because the causes of action giving rise to these proceeds do not exist outside of bankruptcy. See In re Williams, 152 B.R. 123, 129 (Bankr. N.D. Tex. 1992) ('Congress enacted the avoidance provisions of Chapter 5 of the Code to permit a fiduciary of the [bankruptcy] estate to recapture assets to be equitably distributed to the creditors of the [bankruptcy] estate.'). By aggressively negotiating this issue pre-petition, a debtor may be able to achieve better results than a committee can post-petition, and may be able to demonstrate that it can be trusted to protect the interests of unsecured creditors if a committee is not appointed.

The Ostensibly Plan-Insolvent Estate

Some debtors find themselves with insufficient funds to pay administrative and/or priority creditors, with no hope of remedying the situation. In smaller cases, it may be possible to confirm a plan in these circumstances by negotiating on a one-to-one basis with such creditors, since these creditors can consent to less than full payment. In the larger cases in which we participate, this is typically not feasible given the sheer number of creditors involved. However, there are strategies even in these most difficult of circumstances by which plans can be confirmed.

In both In re Trans World Airlines, Inc, No. 01-00056 (PJW) (Bankr. D. Del. January 10, 2001) and In re Teligent Inc., 282 B.R. 765 (Bankr. S.D.N.Y. 2002), administrative and priority creditors were deemed to have consented to the acceptance less than full payment of their claims under section 1129(a)(9).

In Teligent, the debtors' estates were administratively insolvent. The only facially apparent option to confirming a plan was to gain the consent of every administrative and priority creditor to accept less than full payment under section 1129(a). However, there were over 2000 of these creditors. Therefore, the court permitted the Debtors to prepare a consent form that was sent to each of the administrative and priority creditors. The form explained that the case would be converted or dismissed unless each administrative creditor agreed to accept less than full payment under the plan. The affected creditors were given three options to choose from and asked to return the consent form. Any creditor who failed to return a consent form was deemed to consent to the treatment it would receive under the plan. The court acknowledged that 'consent' generally meant affirmative acceptance, Teligent at 772. However, the court went on the state that bankruptcies give rise to 'unique moral and ethical concerns' because one creditor's inaction may affect the fate of everyone in the case, Teligent at 772. The court held that the debtors' procedures provided a 'quick, easy and inexpensive' way for each affected creditor to object to its treatment. Therefore, under the circumstances of that case, the court reasoned that the failure to return a consent form could be treated as an implied agreement, Teligent at 772.

A similar procedure was used in TWA; however, the debtors did not rely on a separate court approved consent form. Instead, the disclosure statement contained numerous disclosures about the debtors' intent to pay administrative creditors less than the full amount of their claims. The affected administrative and priority creditors were required to file an objection to the plan to avoid being deemed to consent to this treatment. In response to an objection to this procedure from the United States Trustee, the debtors pointed out section 1129(c) requires consent, but nowhere does it require 'affirmative consent.' The TWA court confirmed the debtors' plan and overruled the objection of the United States Trustee.

Conclusion

While each Chapter 11 case and debtor is unique, many of the strategies suggested in this article are flexible enough to be tailored to a wide range of situations. If one utilizes appropriate 'front-end' strategies early in the case, and knows the usefulness of appropriate 'back-end' strategies, administering a Chapter 11 liquidation may be quicker and cheaper.

Jonathan P. Friedland and Evan R. Gartenlaub are attorneys in the Restructuring, Workout and Bankruptcy Group in the Chicago office of Kirkland & Ellis.

The fact pattern is all too common: A company with an extremely over-leveraged balance sheet is hemorrhaging cash and may already be in disrepute with its trade creditors (of whom there may be thousands). The business is beyond repair. A bank group that has liens on nearly all of the company's assets wants to use Chapter 11 to liquidate those assets to recover as much as it can. The liquidation may be piecemeal (as is common with failed retailers) or it may be as a going concern (as is more common in the industrial sector), but either way the debtors are heading toward a Chapter 11 liquidation.

Unsecured creditors typically recover next to nothing in these liquidations. Moreover, there is not even the potential upside of ownership in a reorganized company as is common in non-liquidating cases. In the case of a piecemeal liquidation, there is usually no hope of new business with a reorganized company on a go-forward basis, as occurs in many other Chapter 11 cases. Employee morale is difficult to manage because employees know from the onset that it is just a matter of time before they lose their jobs. Furthermore, accounts receivable sometimes become difficult to collect. Liquidating Chapter 11 cases often end in administrative insolvency or at least plan insolvency (that is, the inability to pay priority claims in full on the effective date. But note that for a plan to be confirmable, section 1129(a) of the Bankruptcy Code requires that all holders of administrative and priority claims be paid in full on their claims on the effective date, unless they consent to other treatment under the plan.). This in turn often results in conversion or dismissal. Such an outcome is often unfortunate for all parties, including administrative and priority creditors who generally receive less than they would have under a confirmed Chapter 11 plan.

In this article, we share some of the strategies we have used with success to confirm Chapter 11 plans under these difficult circumstances. We start with 'front-end' strategies that may be used when entering Chapter 11, to prevent problems from arising in the first instance. We then discuss 'back-end' strategies that may be utilized as a case progresses.

As a threshold matter, there is a question of whether it is even permissible to file these cases. Some judges have been heard to say that they will not allow their courtrooms to be used to liquidate secured creditors' collateral. However, most courts do allow it ' the Bankruptcy Code does not prohibit a Chapter 11 simply because its primary beneficiaries will be secured creditors. Many judges, however, condition these cases on the provision of a carve-out for professional fees. These judges consider it the 'price of admission' secured creditors must pay in order to obtain the substantial benefits of Chapter 11 (Perhaps the most famous statement of this point of view is contained in an open letter Bankruptcy Judge Peter J. Walsh wrote to members of the Delaware bankruptcy bar on April 2, 1998).

Carve-Outs

Professional fee carve-outs are common features in bankruptcy cases. Without a carve-out to assure payment, other creditors could find themselves funding professional fees that are incurred primarily to benefit secured creditors. Moreover, professionals would bear the risk that a case will be successful enough to enable payment. We have argued with success in certain cases that the section 506(c) rationale supporting professional fee carve-outs is equally applicable to support carve-outs for other administrative creditors (Section 506(c) authorizes a debtor-in-possession (or trustee) to 'recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim').

The apex of a debtor's leverage to make these arguments, of course, is before a case is filed. While a carve-out is not a panacea because it will always be subject to a negotiated budget, a disciplined approach toward cost-control during a case is in any event essential.

General Cost Saving Measures

An estate's costs can be reduced with straightforward measures such as shopping for reduced rates on copying, teleconference, and other services. These are simple, but often neglected points. Appropriate venue selection can also keep administrative costs down because of varying judicial views on the administrative status of certain claims. For example, the First and Third Circuits consider the post-petition portion of severance pay for post-petition termination of 'rank-and-file' employees to be an administrative expense, while the Second Circuit generally accords the entirety of such severance claims administrative priority. (See, Roger Higgins, Severance Pay and the Termination of Employees During Bankruptcy, The Bankruptcy Strategist, July 2002). A similar circuit split exists between the Third and Seventh Circuits regarding unpaid taxes accrued pre-petition but billed post-petition by landlords.

More creative cost saving can be utilized in appropriate situations as well. For example, we recently saved hundreds of thousands of dollars in copying and mailing costs by serving a 'short form disclosure statement' (about a dozen pages) on all creditors entitled to vote on a plan instead of the several-hundred-page plan and disclosure statement that was made available only to those creditors who requested it after receiving the short form. While the Bankruptcy Code does not specifically authorize a short-form disclosure statement, neither is it prohibited. (Bankruptcy Rule 3017(d)(1) requires the distribution of 'the plan or a court-approved summary of the plan.' The Rule makes no mention of a disclosure statement summary.) Moreover, a shorter document may be easier to read and understand, especially where information is being delivered to large numbers of relatively unsophisticated creditors, such as customers.

Confirm As Early As Possible

One of the most effective ways to minimize costs of a Chapter 11 case is to end it by confirming a Chapter 11 plan as expediently as possible. A key drawback to Chapter 11 is the inherent redundancy of the process. Multiple sets of professionals (representing the interests of the debtors, creditors, as well as other parties) must often be borne by the estate. In addition, if a debtor can demonstrate that it can be depended on to protect the interests of unsecured creditors, it may be able to effectively argue against the appointment of counsel for an unsecured creditors committee, another cost-saving result. If a committee is appropriate, however, a good relationship with committee counsel can be crucial to running an efficient estate.

While fees and other expenses associated with a Chapter 11 case are, to some extent, unavoidable, they can be minimized by seeking confirmation as early in the process as possible. Early confirmation may be achieved by diligent work and sensible compromises on potentially contentious issues as early in the case as possible. Confirmation, however, usually requires a debtor to have enough cash to pay all accrued administrative expenses and priority claims near the date of confirmation of the Chapter 11 plan. This is not always feasible. To overcome this obstacle, in appropriate circumstances, a delayed effective date may be appropriate.

Delayed Effective Date

When a debtor can prove it will have sufficient funds to effectuate the distributions called for under its plan at a certain future date, but will not possess those funds at or shortly after confirmation (perhaps due to the delay in selling a piece of property or in collecting on avoidance actions or insurance payments), the debtor may attempt to confirm a plan that delays the effective date until such funds will be available, even if such a period is months after confirmation.

A delayed effective date allows a post-confirmation estate to come into existence more quickly, thus eliminating (or at least greatly reducing) the redundancy of the Chapter 11 process. Similarly, the need to go to court may be reduced in post-confirmation settings, as authority is often transferred from a court-supervised debtor-in-possession to a trust controlled by trustees.

Case law is sparse on this topic and we have only attempted this route (with success) once. The Code does not define the term 'effective date.' In In re Rolling Green Country Club, 26 B.R. 729, 734-35 (Bankr. D. Minn. 1982), the court upheld an effective date tied to the accumulation of fund necessary to make certain payments required under the plan. The court in In re Inter Urban Broadcasting of Cincinnati, Inc., Case No. 94-2382-83, 1994 WL 646176 (E.D. La. Nov. 16, 1994) took a similar approach, upholding an effective date that was the date a radio station was sold, and was later redefined to be a date no later than 15 days after FCC approval of a license agreement or the date the confirmation became final. However, in In re Potomac Iron Works, 217 B.R. 170 (Bankr. D. Md. 1997), the court held that a 1-year delay between entry of the confirmation order and the effective date was unreasonable. (It should be noted that in its decision, the Potomac court inaccurately quotes the court in In re Rolling Green County Club, and incorrectly characterizes the holding of the Rolling Green court as disallowing a delayed effective date.) In Potomac, the feasibility of the plan depended on the successful collection of accounts receivable that were owed to the Debtor. Various parties, including local taxing authorities, objected to the Plan, questioning the collectability of the accounts receivable. Because there is no per se prohibition against a delayed effective date, we think the issue is most appropriately examined under the lens of a feasibility analysis if the equities of the case warrant it and if supported by creditors.

Chapter 5 Causes of Action

A secured creditor may take the position that it has a lien against any proceeds from Chapter 5 causes of action, such as recoveries of preferences. While, a secured creditor's lien on substantially all of the debtor's assets might include such proceeds, the analysis should not end there. A debtor has a persuasive argument that the secured creditor should not be entitled to a lien on the proceeds of such litigation because the causes of action giving rise to these proceeds do not exist outside of bankruptcy. See In re Williams, 152 B.R. 123, 129 (Bankr. N.D. Tex. 1992) ('Congress enacted the avoidance provisions of Chapter 5 of the Code to permit a fiduciary of the [bankruptcy] estate to recapture assets to be equitably distributed to the creditors of the [bankruptcy] estate.'). By aggressively negotiating this issue pre-petition, a debtor may be able to achieve better results than a committee can post-petition, and may be able to demonstrate that it can be trusted to protect the interests of unsecured creditors if a committee is not appointed.

The Ostensibly Plan-Insolvent Estate

Some debtors find themselves with insufficient funds to pay administrative and/or priority creditors, with no hope of remedying the situation. In smaller cases, it may be possible to confirm a plan in these circumstances by negotiating on a one-to-one basis with such creditors, since these creditors can consent to less than full payment. In the larger cases in which we participate, this is typically not feasible given the sheer number of creditors involved. However, there are strategies even in these most difficult of circumstances by which plans can be confirmed.

In both In re Trans World Airlines, Inc, No. 01-00056 (PJW) (Bankr. D. Del. January 10, 2001) and In re Teligent Inc., 282 B.R. 765 (Bankr. S.D.N.Y. 2002), administrative and priority creditors were deemed to have consented to the acceptance less than full payment of their claims under section 1129(a)(9).

In Teligent, the debtors' estates were administratively insolvent. The only facially apparent option to confirming a plan was to gain the consent of every administrative and priority creditor to accept less than full payment under section 1129(a). However, there were over 2000 of these creditors. Therefore, the court permitted the Debtors to prepare a consent form that was sent to each of the administrative and priority creditors. The form explained that the case would be converted or dismissed unless each administrative creditor agreed to accept less than full payment under the plan. The affected creditors were given three options to choose from and asked to return the consent form. Any creditor who failed to return a consent form was deemed to consent to the treatment it would receive under the plan. The court acknowledged that 'consent' generally meant affirmative acceptance, Teligent at 772. However, the court went on the state that bankruptcies give rise to 'unique moral and ethical concerns' because one creditor's inaction may affect the fate of everyone in the case, Teligent at 772. The court held that the debtors' procedures provided a 'quick, easy and inexpensive' way for each affected creditor to object to its treatment. Therefore, under the circumstances of that case, the court reasoned that the failure to return a consent form could be treated as an implied agreement, Teligent at 772.

A similar procedure was used in TWA; however, the debtors did not rely on a separate court approved consent form. Instead, the disclosure statement contained numerous disclosures about the debtors' intent to pay administrative creditors less than the full amount of their claims. The affected administrative and priority creditors were required to file an objection to the plan to avoid being deemed to consent to this treatment. In response to an objection to this procedure from the United States Trustee, the debtors pointed out section 1129(c) requires consent, but nowhere does it require 'affirmative consent.' The TWA court confirmed the debtors' plan and overruled the objection of the United States Trustee.

Conclusion

While each Chapter 11 case and debtor is unique, many of the strategies suggested in this article are flexible enough to be tailored to a wide range of situations. If one utilizes appropriate 'front-end' strategies early in the case, and knows the usefulness of appropriate 'back-end' strategies, administering a Chapter 11 liquidation may be quicker and cheaper.

Jonathan P. Friedland and Evan R. Gartenlaub are attorneys in the Restructuring, Workout and Bankruptcy Group in the Chicago office of Kirkland & Ellis.