Business Bankruptcy–Pre-Filing Considerations

Business Bankruptcy – Simplified Operating Guidelines

A "How-To" Manual

For Non-Bankruptcy Professionals
Page 3
Robert S. Apfelberg, Karrie L. Bercik, Esq.

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Chapter 2. Pre-Filing Considerations

Most business bankruptcies are filed at a crisis time. However, businesspersons contemplating a chapter 11 ("pre-petition") should plan ahead for particularly critical issues.

A. The Automatic Stay and Guarantors

Immediately after filing of the chapter 11 petition ("post-petition" or "administrative period") all creditors are prohibited from performing any action to collect pre-petition debts or improve their pre-petition legal position relative to the debtor ("automatic stay"). This typically means the cessation of law suits, collection efforts of any kind, set-offs, foreclosures, seizures and withholding deliveries until pre-petition debts are paid. However, the automatic stay typically does not stop creditors from demanding payment from any non-debtor guarantors ("guarantors").

The court may enjoin creditors from pursuing guarantors if such collection efforts would seriously and adversely affect: (i) management actively involved in the debtor’s operations, (ii) essential operating property of the debtor, or (iii) the debtor’s ability to effectively utilize people and property essential to achieving a successful business reorganization ("confirmation of a plan of reorganization" or "reorganization"). If it is only inconvenient to the debtor or creates a hardship on the guarantors, it is unlikely that the court will enjoin creditors from pursuing guarantors.

B. Operating Capital

Secured lenders, such as banks, factors, bond holders, etc. ("secured lenders") have created a lien on the proceeds from a business’ collection of accounts receivable or sale of inventory and equipment ("cash collateral proceeds"). However, the secured lender has actually authorized the business to use its cash collateral proceeds to pay its daily operating expenses.

The debtor must obtain new administrative period authority to use cash collateral ("cash collateral agreement" or "cash collateral stipulation") on an expedited basis, or it will quickly run out of operating capital. The secured lender is given an opportunity to negotiate for a better legal position during the administrative period. Often they will demand a waiver of all of the debtor’s prior claims against the secured lender. They may require the debtor to renew the cash collateral agreement every ninety days.

The debtor’s unsecured creditors, ("unsecured creditors"), generally merchandise and inventory suppliers ("trade suppliers" or "the trade"), receive increased protection during the administrative period. Trade suppliers and others, typically represented by an executive committee of 5-7 unsecured creditors ("unsecured creditors committee" or "committee"), and other interested parties, will carefully scrutinize any cash collateral agreement between the debtor and the secured lender.

The debtor’s management should attempt to limit the concessions granted to the secured lender to avoid a court battle with the other interested parties. It is usually helpful to quickly involve the unsecured creditors committee, if it has been formed, and other powerful interested parties in the cash collateral agreement negotiations. The court must approve the cash collateral stipulation.

The debtor may request court approval for use of cash collateral without the agreement of the secured lender. The courts are generally interested in allowing the debtor a chance to reorganize and recognize its urgent need for operating capital. However, the secured lender has powerful rights and strategic position. It is extremely difficult to win a cash collateral battle. The debtor must demonstrate that the lender’s collateral will not be diminished ("impaired") during the administrative period, by utilizing proforma financial statements and business and equipment valuations.

Any motion to obtain court approval for the use of cash collateral will require notice to all creditors. The debtor may request this notice period be upon shortened time ("emergency motion shortening time").

C. Attorney and Professional Fees

Bankruptcy attorneys will require a substantial retainer prior to becoming the debtor’s chapter 11 counsel ("debtor’s counsel"). Initial retainers may range from $15,000 to $350,000 depending on the scope of the debtor’s operations. Pre-petition it is advisable for businesspersons to create a "war chest" of funds to pay the retainer and provide operating capital until court approval of the cash collateral agreement. If possible, the debtor’s counsel’s retainer should be paid from funds that are not subject to a secured lender’s lien.

The court must pre-approve the employment and payment of all administrative period professionals with the other interested parties given an opportunity to object. "Professionals" include: (i) bankruptcy counsel, (ii) non-bankruptcy legal counsel, (iii) accountants, (iv) consultants, (v) real estate, business or machinery and equipment brokers, and (vi) business valuators or real estate appraisers.

D. Public Disclosure and Notification

Immediately upon filing the chapter 11 petition, and periodically during the administrative period, both private and public company debtors should issue press releases and send explanatory letters to their entire mailing list ("public statements"). Public statements should additionally be issued for all significant events.

An initial public statement should include: (i) the events leading up to the filing, (ii) any recent improvements in operations or personnel, (iii) the anticipated continuation of the debtor’s operations, (iv) the anticipated ability to recover and strengthen operations (to "reorganize"), (v) that a chapter 11 ("operating case") was filed rather than a chapter 7 ("liquidating case"), (vi) the anticipated effects on the employees, customers, trade creditors and the local community, and (vii) management, shareholders, customers and any secured or trade creditor’s statements of support for the debtor.

It is beneficial, but risky, to personally provide carefully structured advance notice of a chapter 11 filing to certain secured lenders, trade suppliers, shareholders, affiliates and senior employees. However, public companies must time this advance notification carefully to avoid insider information concerns. Both private and public companies must be aware of the possibility of a pre-emptive action by interested parties with advance notice of an intended bankruptcy filing.

E. Employee Issues

Employees usually know that a business is in trouble before management officially tells them. After the bankruptcy petition has been filed and the company becomes a debtor-in-possession employees will be even more concerned about their future. The debtor should immediately inform its employees of: (i) the reasons for the filing, (ii) its benefits and problems, (iii) that the company pragmatically has become stronger by not being allowed or required to pay prior debts, and (iv) that the debtor must stay current in all of its post-petition ("administrative period") payments, including employee wages.

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