From Cradle to Grave: Using Bankruptcy Skills to Advise Clients on New Deals

Part Two of a Two-Part Article

Last month, we discussed the fact that of the many hats worn by leasing attorneys, one is of the bankruptcy practitioner. It is a skill set that usually comes into play at the end of a transaction gone bad. This article continues outlining the case for ending this practice and having bankruptcy counsel get involved in lease deals from the outset.

SIXTH RULE: GET A SECURITY INTEREST. Unsecured creditors may be last on line to get a distribution in a bankruptcy case, if any, and are unable to obtain relief from the stay to enforce their remedies. Secured creditors also get post-petition interest and attorneys' fees to the extent that the value of their collateral exceeds the amount of their pre-petition claim. They also are entitled to adequate protection if their collateral is used or sold, and have special protections in a cram down, giving them great leverage in a bankruptcy case. Accordingly, bankruptcy lawyers know that it is a good idea to find out what free assets a debtor has before the deal is done and bargain for a first priority security interest.

There is another area where a security interest might be beneficial. Under certain circumstances, the creditors of a debtor may assert an interest in assets that the client thinks it owns. For example, property that is subject to a consignment or bailment may be available to creditors of the bailee or consignee, even though, under state law, that property is owned by the client. An asset may be “property of the estate” simply because the debtor has a right to possession, not ownership. In reclamation proceedings, a creditor with a floating lien on the debtor's inventory may trump the supplier who provided the goods. Furthermore, in foreign legal systems, property ownership may have different rules. For example, in Germany, a manufacturer of products for a third party may be deemed to own those products, making them available to its trustee in bankruptcy and creditors, even though the contract expressly provided that the products were the property of the third party. A landlord may have a lien that applies to all property on the debtor's premises, even if the debtor does not own them.

Accordingly, although it seems counter-intuitive, the client might want to take a security interest in the subject matter, products and proceeds of the contract, even though under state law, it would own these assets. In the event that a court finds that the debtor, its trustee, or a creditor of the debtor holds an interest in those assets, the original owner at least will be first in line by holding a priority security interest.

SEVENTH RULE: GET AN OVERVIEW OF APPLICABLE FOREIGN LAW. If the contract extends to countries other than the United States, get an overview of the law of that country as to bankruptcy, security interests, and enforcing foreign judgments. For example, in some European countries, the collateral of secured creditors can be invaded to pay administrative expenses or the claims of employees, which must be paid in full and cannot be restructured under a plan. In Germany, there is no recordation or registration of security interests, and a representation and warranty that no other security interests exist or will be granted may be useless if a bankruptcy ensues or the debtor becomes judgment-proof. Accordingly, a secured creditor must obtain a transfer or assignment of its collateral from the debtor in order to protect its secured position.

The best way to check this out is to retain counsel in the countries in which the contract will be performed. The client might be the best source of referrals because it may do business in those countries and have counsel it generally uses.

In addition, it is important to get an overview of the foreign legal system yourself to spot issues that a foreign lawyer might not catch because fundamental concepts may differ, causing them to miss an important factor. Discussions of foreign legal systems can be found using the websites of the American Bankruptcy Institute, findlaw.com, internal law Web sites, computer research services such as Westlaw, or on-line search vehicles, all of which can be used to find general and comparative articles on foreign legal systems. For example, demanding foreign registration of a security interest or copyright mortgage might not be “a hill worth dying for” in a country that has no reliable system of recordation, and may require a creative alternative to protect the client.

EIGHTH RULE: DO DUE DILIGENCE. Decades ago, I was involved in a bankruptcy case where the debtor granted security interests in phony computer leases to major lending institutions in exchange for millions of dollars in financing. This issue recently resurfaced in a licensing deal in which I was involved, where the licensor demanded a huge upfront fee but had no concomitant duty to prove at that time that it owned the licensed products or had the ability to license the rights in the foreign jurisdictions at issue. Due diligence revealed that it did not have those rights, which were held by other entities in a tangled web of related partnerships, LLCs, and shell corporations with similar names.

This seems so fundamental, but it is imperative to verify the chain of title of any assets that are the subject matter of the transaction or that are being given as collateral; to do a UCC and lien search to make sure that there are no prior interests; to make sure that any entity that is providing services is a party to the contract and bound by its provisions, not just the parent that negotiated the overall transaction.

NINTH RULE: ANALYZE THE TRANSACTION FROM THE VIEWPOINT OF HOW YOU WOULD ATTACK IT IF YOU REPRESENTED THE OTHER SIDE. On a daily basis, bankruptcy lawyers are faced with the task of dismantling transactions drafted by other attorneys pre-petition. This is not only a matter of using Bankruptcy Code provisions, but also using rules of contract interpretation. As a result, this ability provides bankruptcy lawyers with one of the best tools to prevent future disputes.

A bankruptcy lawyer effectively can vet a deal, to wit, plow through a prospective transaction from the viewpoint of how he/she would eviscerate its provisions in a bankruptcy case, including where is it ambiguous, how does it treat waivers, who drafted the documents and therefore how the presumption against the drafter can be used, is it usurious, does it violate any federal or state law, how would it be treated in bankruptcy? Then, the same lawyer can fix the flaws found, based on how they would like the contract to read if they were charged with its enforcement.

Part Two of a Two-Part Article

Last month, we discussed the fact that of the many hats worn by leasing attorneys, one is of the bankruptcy practitioner. It is a skill set that usually comes into play at the end of a transaction gone bad. This article continues outlining the case for ending this practice and having bankruptcy counsel get involved in lease deals from the outset.

SIXTH RULE: GET A SECURITY INTEREST. Unsecured creditors may be last on line to get a distribution in a bankruptcy case, if any, and are unable to obtain relief from the stay to enforce their remedies. Secured creditors also get post-petition interest and attorneys' fees to the extent that the value of their collateral exceeds the amount of their pre-petition claim. They also are entitled to adequate protection if their collateral is used or sold, and have special protections in a cram down, giving them great leverage in a bankruptcy case. Accordingly, bankruptcy lawyers know that it is a good idea to find out what free assets a debtor has before the deal is done and bargain for a first priority security interest.

There is another area where a security interest might be beneficial. Under certain circumstances, the creditors of a debtor may assert an interest in assets that the client thinks it owns. For example, property that is subject to a consignment or bailment may be available to creditors of the bailee or consignee, even though, under state law, that property is owned by the client. An asset may be “property of the estate” simply because the debtor has a right to possession, not ownership. In reclamation proceedings, a creditor with a floating lien on the debtor's inventory may trump the supplier who provided the goods. Furthermore, in foreign legal systems, property ownership may have different rules. For example, in Germany, a manufacturer of products for a third party may be deemed to own those products, making them available to its trustee in bankruptcy and creditors, even though the contract expressly provided that the products were the property of the third party. A landlord may have a lien that applies to all property on the debtor's premises, even if the debtor does not own them.

Accordingly, although it seems counter-intuitive, the client might want to take a security interest in the subject matter, products and proceeds of the contract, even though under state law, it would own these assets. In the event that a court finds that the debtor, its trustee, or a creditor of the debtor holds an interest in those assets, the original owner at least will be first in line by holding a priority security interest.

SEVENTH RULE: GET AN OVERVIEW OF APPLICABLE FOREIGN LAW. If the contract extends to countries other than the United States, get an overview of the law of that country as to bankruptcy, security interests, and enforcing foreign judgments. For example, in some European countries, the collateral of secured creditors can be invaded to pay administrative expenses or the claims of employees, which must be paid in full and cannot be restructured under a plan. In Germany, there is no recordation or registration of security interests, and a representation and warranty that no other security interests exist or will be granted may be useless if a bankruptcy ensues or the debtor becomes judgment-proof. Accordingly, a secured creditor must obtain a transfer or assignment of its collateral from the debtor in order to protect its secured position.

The best way to check this out is to retain counsel in the countries in which the contract will be performed. The client might be the best source of referrals because it may do business in those countries and have counsel it generally uses.

In addition, it is important to get an overview of the foreign legal system yourself to spot issues that a foreign lawyer might not catch because fundamental concepts may differ, causing them to miss an important factor. Discussions of foreign legal systems can be found using the websites of the American Bankruptcy Institute, findlaw.com, internal law Web sites, computer research services such as Westlaw, or on-line search vehicles, all of which can be used to find general and comparative articles on foreign legal systems. For example, demanding foreign registration of a security interest or copyright mortgage might not be “a hill worth dying for” in a country that has no reliable system of recordation, and may require a creative alternative to protect the client.

EIGHTH RULE: DO DUE DILIGENCE. Decades ago, I was involved in a bankruptcy case where the debtor granted security interests in phony computer leases to major lending institutions in exchange for millions of dollars in financing. This issue recently resurfaced in a licensing deal in which I was involved, where the licensor demanded a huge upfront fee but had no concomitant duty to prove at that time that it owned the licensed products or had the ability to license the rights in the foreign jurisdictions at issue. Due diligence revealed that it did not have those rights, which were held by other entities in a tangled web of related partnerships, LLCs, and shell corporations with similar names.

This seems so fundamental, but it is imperative to verify the chain of title of any assets that are the subject matter of the transaction or that are being given as collateral; to do a UCC and lien search to make sure that there are no prior interests; to make sure that any entity that is providing services is a party to the contract and bound by its provisions, not just the parent that negotiated the overall transaction.

NINTH RULE: ANALYZE THE TRANSACTION FROM THE VIEWPOINT OF HOW YOU WOULD ATTACK IT IF YOU REPRESENTED THE OTHER SIDE. On a daily basis, bankruptcy lawyers are faced with the task of dismantling transactions drafted by other attorneys pre-petition. This is not only a matter of using Bankruptcy Code provisions, but also using rules of contract interpretation. As a result, this ability provides bankruptcy lawyers with one of the best tools to prevent future disputes.

A bankruptcy lawyer effectively can vet a deal, to wit, plow through a prospective transaction from the viewpoint of how he/she would eviscerate its provisions in a bankruptcy case, including where is it ambiguous, how does it treat waivers, who drafted the documents and therefore how the presumption against the drafter can be used, is it usurious, does it violate any federal or state law, how would it be treated in bankruptcy? Then, the same lawyer can fix the flaws found, based on how they would like the contract to read if they were charged with its enforcement.