Chapter 11 Plans of Reorganization and Equipment Lessors

Two Critical Documents

There are two essential documents a lessor should examine once it has been learned that a bankruptcy petition has been filed. One is the Disclosure Statement, which is more detailed and describes the Plan, and the other is the debtor's Chapter 11 Plan. These are by no means the only documents that an equipment lessor should review, but these documents are extremely important. The culmination of a DIP's Chapter 11 case is to have the bankruptcy court conduct a confirmation hearing and confirm a DIP's Plan. However, the first step in that process is the court's approval of the DIP's Disclosure Statement.

The Disclosure Statement (“DS”) is a document the DIP files as a requirement of Bankruptcy Code ' 1125 that the DIP provide “adequate information” to its creditors. “'Adequate information' means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor's books and records, including a discussion of the potential material Federal tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case, that would enable such a hypothetical investor of the relevant class to make an informed judgment about the plan ' .” 11 U.S.C. ' 1125. The DS is helpful in allowing an equipment lessor to review a Summary of the Plan and the Plan's treatment of the lessor as well as a general description of why the DIP filed bankruptcy and what it intends to do before it exits bankruptcy.

However, the reading does not stop there because the equipment lessor must read the Plan to make sure of its treatment. The Plan provides for the treatment of the DIP's creditors, including the equipment lessors. You want to read it with an eye toward how you will be treated as an equipment lessor. Plans may set forth a general treatment such as ' all leases are rejected unless otherwise assumed. You may realize that the two documents are somewhat repetitive, but the DIP is required to file both documents and the DS is the more descriptive document. A Plan usually contains a phrase to the effect that if there are any inconsistencies between the DS and the Plan, the language of the Plan controls.

The DIP's Motion to Approve the Disclosure Statement

In addition to the DS and Plan, the lessor should also be prepared to read the Motion to Approve the DS. This motion generally summarizes the DS, and it attaches to it the DS and the Plan.

The Motions to Assume and the Motions to Reject Leases

Throughout a bankruptcy case, a DIP may file one or more Motions to Assume Executory Contracts and Unexpired Leases (“Motion to Assume”) and it may file one or more Motions to Reject Executory Contracts and Unexpired Leases (“Motion to Reject”). The best way to think of these motions is that they are the DIP's mechanisms to rid itself of undesirable leases and keep the desirable leases. This decision is made based on the DIP's business judgment and any challenge to the decision to the DIP's decision to assume or reject will be confronted with challenging the DIP's business judgment. A court must approve the DIP's decision to Assume or Reject a lease. Generally, an equipment lessor will want to protect itself from an adverse decision and a lease cannot be both assumed and rejected.

Lease Acceptance or Rejection

DIPs use their business judgment when deciding whether to assume or reject a given lease. The emphasis of this article is not so much to understand why a DIP may assume or reject an Unexpired Lease or Executory Contract, but what an equipment lessor may and should do to protect its rights after the DIP decides to either assume or to reject a give lease.

The best place to start is Bankruptcy Code ' 365. Section 365 provides, in relevant part:

“(a) Except as provided in sections 765 and 766 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.

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(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee ' (A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property ' .”

A Lessor's Objection to Lease Assumption

In a DIP's Motion to Assume, it will include a “Cure” amount. That is the amount of money that the DIP owes the equipment lessor for a prior default under the lease. If a lessor does not object to the cure provided by the DIP, the DIP's statement of the cure amount is controlling. Practically speaking, an equipment lessor whose lease is subject to a Motion to Assume, should file an Objection to the Assumption if the cure amount is incorrect. If not, the cure amount as stated by the Debtor will be the cure amount ordered by the court. Some DIPs just put a $0 cure, and leave it up to the lessor to object or get $0.00.

A Lessor's Objection to Lease Assignment

A DIP's Motion to Assume will generally provide that the lease is to be assigned to an assignee of the DIP's choice. For example, if your lease is to be assigned to the DIP's purchaser, you may want to file an additional objection if you are not confident that the purchaser has the financial wherewithal to provide you with adequate assurance of continued performance under the lease.

A Lessor's Filing of'a Rejection Damages' Proof of Claim

As set forth herein, a DIP's decision to reject a lease subject to its own business judgment. Pursuant to the Bankruptcy Code, a rejection of a lease constitutes a “breach” of such lease. 11 U.S..C. ' 365(g). I will therefore not address filing an Objection to the Debtor's Motion to Reject. If you decided to question the DIP's business judgment you will need a lawyer to go to court for you with experts to challenge the DIP.

This article addresses what you should practically do if the DIP files a Motion to Reject your lease and the court orders the lease rejected. The Order Rejecting the Lease will generally provide you with a deadline to file a Proof of Claim for Rejection Damages. A typical method for such a calculation would be to take the past due payments and the stream of all future payments (discounted to present value) and subtract any mitigation such as sale proceeds from the returned equipment or the present value of the rent stream from future leasing of the item. A lessor can add expenses of re-letting and attorney fees if or when the lease permits.

The DIP's Plan and the Treatment of Unexpired Leases and Executory Contracts

If your lease was not otherwise assumed in a Motion filed by the DIP to Assume Executory Contracts and Unexpired Leases, you will have to look at the Plan's Schedules or Exhibits because they usually have the treatment of each of the leases. If you believe there is a problem with the cure amount stated in the Plan for your Lease, you should Object to Confirmation and Cure.

A DIP's Plan may refer to a Plan Supplement or Exhibit containing specific treatment of the leases. The Plan may state that the Plan Supplement or Exhibit will not be filed until a week before the Confirmation Hearing and after the Objection Deadline to Confirmation. If this is the case, the DIP will generally provide a second Objection Deadline for Objections of Lessors to Cure. As set forth herein, cure is defined earlier in this article as the amount of money that the DIP agrees to pay the lessor to cure the DIP's prior default under the lease. Under this scenario, if a lessor does not object to the cure provided by the DIP before the objection deadline for the Plan Supplement or Exhibit, the DIP's statement of the cure amount is controlling.

Conclusion

A DIP that seeks to sell all of its assets often assumes and assigns some of its leases. In response, an equipment lessor must not just file a Proof of Claim, but also review the Motions to Assume or Reject as filed by the DIP, the DS, the Plan and any of its Plan Supplements regarding the treatment of the particular lessor. The Chapter 11 process occurs at a fast clip now, so the equipment lessor should monitor a lessee's bankruptcy case accordingly to protect its rights.

Deirdre M. Richards is a partner at Fineman Krekstein & Harris PC in Philadelphia. Ms. Richards concentrates her practice in bankruptcy litigation, loan workouts and commercial litigation in Pennsylvania, New Jersey and Delaware. She is also a member of the Legal Committee for the Equipment Leasing and Finance Association. Contact her at [email protected].

Filing Chapter 11 is a very expensive proposition these days. The filing fees, coupled with the astronomical attorneys' and special litigation counsels' fees, plus the accountants' fees, are just a few of the expenses for a debtor-in-possession (“DIP”). So what does this mean for us as equipment lessors? It means we must react accordingly and often very quickly to protect ourselves.

It means that many company DIPs set up their exit strategy before they file Chapter 11 to minimize the time that they are in a Chapter 11 bankruptcy proceeding and thereby minimize their costs for attorneys and other fees that the DIPs incur. That equates to us, as equipment lessors, having to play catch-up after being taken by surprise by a slew of so-called “First Day Motions” (such as Motions to Approve Cash Collateral or Debtor-in-Possession Financing, Motions to Pay Pre-Petition Wages, Motions to Pay Utilities, Motions to Pay Critical Vendors, Motions to Employ DIP Attorneys and others similar motions). You might even see a Motion to Sell Substantially All Assets of the DIP, or a Disclosure Statement and Plan of Reorganization filed just a few weeks after the Chapter 11 filing. Just as we are reading the court orders on the First Day Motions, we are inundated with additional pages of documents to read and analyze in order to protect our rights before it's too late.

At this point the equipment lessor might have already decided to engage its own attorney to review the various DIP motions for their respective impact on the equipment lessor. It is generally best to know what relief the DIP seeks and determine its impact on the equipment lessor before there is a binding court order permitting the DIP to infringe on an equipment lessor's rights.

Two Critical Documents

There are two essential documents a lessor should examine once it has been learned that a bankruptcy petition has been filed. One is the Disclosure Statement, which is more detailed and describes the Plan, and the other is the debtor's Chapter 11 Plan. These are by no means the only documents that an equipment lessor should review, but these documents are extremely important. The culmination of a DIP's Chapter 11 case is to have the bankruptcy court conduct a confirmation hearing and confirm a DIP's Plan. However, the first step in that process is the court's approval of the DIP's Disclosure Statement.

The Disclosure Statement (“DS”) is a document the DIP files as a requirement of Bankruptcy Code ' 1125 that the DIP provide “adequate information” to its creditors. “'Adequate information' means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor's books and records, including a discussion of the potential material Federal tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case, that would enable such a hypothetical investor of the relevant class to make an informed judgment about the plan ' .” 11 U.S.C. ' 1125. The DS is helpful in allowing an equipment lessor to review a Summary of the Plan and the Plan's treatment of the lessor as well as a general description of why the DIP filed bankruptcy and what it intends to do before it exits bankruptcy.

However, the reading does not stop there because the equipment lessor must read the Plan to make sure of its treatment. The Plan provides for the treatment of the DIP's creditors, including the equipment lessors. You want to read it with an eye toward how you will be treated as an equipment lessor. Plans may set forth a general treatment such as ' all leases are rejected unless otherwise assumed. You may realize that the two documents are somewhat repetitive, but the DIP is required to file both documents and the DS is the more descriptive document. A Plan usually contains a phrase to the effect that if there are any inconsistencies between the DS and the Plan, the language of the Plan controls.

The DIP's Motion to Approve the Disclosure Statement

In addition to the DS and Plan, the lessor should also be prepared to read the Motion to Approve the DS. This motion generally summarizes the DS, and it attaches to it the DS and the Plan.

The Motions to Assume and the Motions to Reject Leases

Throughout a bankruptcy case, a DIP may file one or more Motions to Assume Executory Contracts and Unexpired Leases (“Motion to Assume”) and it may file one or more Motions to Reject Executory Contracts and Unexpired Leases (“Motion to Reject”). The best way to think of these motions is that they are the DIP's mechanisms to rid itself of undesirable leases and keep the desirable leases. This decision is made based on the DIP's business judgment and any challenge to the decision to the DIP's decision to assume or reject will be confronted with challenging the DIP's business judgment. A court must approve the DIP's decision to Assume or Reject a lease. Generally, an equipment lessor will want to protect itself from an adverse decision and a lease cannot be both assumed and rejected.

Lease Acceptance or Rejection

DIPs use their business judgment when deciding whether to assume or reject a given lease. The emphasis of this article is not so much to understand why a DIP may assume or reject an Unexpired Lease or Executory Contract, but what an equipment lessor may and should do to protect its rights after the DIP decides to either assume or to reject a give lease.

The best place to start is Bankruptcy Code ' 365. Section 365 provides, in relevant part:

“(a) Except as provided in sections 765 and 766 of this title and in subsections (b), (c), and (d) of this section, the trustee, subject to the court's approval, may assume or reject any executory contract or unexpired lease of the debtor.

**

(b)(1) If there has been a default in an executory contract or unexpired lease of the debtor, the trustee may not assume such contract or lease unless, at the time of assumption of such contract or lease, the trustee ' (A) cures, or provides adequate assurance that the trustee will promptly cure, such default other than a default that is a breach of a provision relating to the satisfaction of any provision (other than a penalty rate or penalty provision) relating to a default arising from any failure to perform nonmonetary obligations under an unexpired lease of real property ' .”

A Lessor's Objection to Lease Assumption

In a DIP's Motion to Assume, it will include a “Cure” amount. That is the amount of money that the DIP owes the equipment lessor for a prior default under the lease. If a lessor does not object to the cure provided by the DIP, the DIP's statement of the cure amount is controlling. Practically speaking, an equipment lessor whose lease is subject to a Motion to Assume, should file an Objection to the Assumption if the cure amount is incorrect. If not, the cure amount as stated by the Debtor will be the cure amount ordered by the court. Some DIPs just put a $0 cure, and leave it up to the lessor to object or get $0.00.

A Lessor's Objection to Lease Assignment

A DIP's Motion to Assume will generally provide that the lease is to be assigned to an assignee of the DIP's choice. For example, if your lease is to be assigned to the DIP's purchaser, you may want to file an additional objection if you are not confident that the purchaser has the financial wherewithal to provide you with adequate assurance of continued performance under the lease.

A Lessor's Filing of'a Rejection Damages' Proof of Claim

As set forth herein, a DIP's decision to reject a lease subject to its own business judgment. Pursuant to the Bankruptcy Code, a rejection of a lease constitutes a “breach” of such lease. 11 U.S..C. ' 365(g). I will therefore not address filing an Objection to the Debtor's Motion to Reject. If you decided to question the DIP's business judgment you will need a lawyer to go to court for you with experts to challenge the DIP.

This article addresses what you should practically do if the DIP files a Motion to Reject your lease and the court orders the lease rejected. The Order Rejecting the Lease will generally provide you with a deadline to file a Proof of Claim for Rejection Damages. A typical method for such a calculation would be to take the past due payments and the stream of all future payments (discounted to present value) and subtract any mitigation such as sale proceeds from the returned equipment or the present value of the rent stream from future leasing of the item. A lessor can add expenses of re-letting and attorney fees if or when the lease permits.

The DIP's Plan and the Treatment of Unexpired Leases and Executory Contracts

If your lease was not otherwise assumed in a Motion filed by the DIP to Assume Executory Contracts and Unexpired Leases, you will have to look at the Plan's Schedules or Exhibits because they usually have the treatment of each of the leases. If you believe there is a problem with the cure amount stated in the Plan for your Lease, you should Object to Confirmation and Cure.

A DIP's Plan may refer to a Plan Supplement or Exhibit containing specific treatment of the leases. The Plan may state that the Plan Supplement or Exhibit will not be filed until a week before the Confirmation Hearing and after the Objection Deadline to Confirmation. If this is the case, the DIP will generally provide a second Objection Deadline for Objections of Lessors to Cure. As set forth herein, cure is defined earlier in this article as the amount of money that the DIP agrees to pay the lessor to cure the DIP's prior default under the lease. Under this scenario, if a lessor does not object to the cure provided by the DIP before the objection deadline for the Plan Supplement or Exhibit, the DIP's statement of the cure amount is controlling.

Conclusion

A DIP that seeks to sell all of its assets often assumes and assigns some of its leases. In response, an equipment lessor must not just file a Proof of Claim, but also review the Motions to Assume or Reject as filed by the DIP, the DS, the Plan and any of its Plan Supplements regarding the treatment of the particular lessor. The Chapter 11 process occurs at a fast clip now, so the equipment lessor should monitor a lessee's bankruptcy case accordingly to protect its rights.

Deirdre M. Richards is a partner at Fineman Krekstein & Harris PC in Philadelphia. Ms. Richards concentrates her practice in bankruptcy litigation, loan workouts and commercial litigation in Pennsylvania, New Jersey and Delaware. She is also a member of the Legal Committee for the Equipment Leasing and Finance Association. Contact her at [email protected].