This blog publishes articles and updates focused on bankruptcy law, restructuring matters, creditor and debtor considerations, court decisions, and procedural developments that affect businesses and individuals navigating financial distress.

Content includes practical analysis of case outcomes, regulatory changes, and emerging trends, as well as perspectives from legal practitioners on how bankruptcy and insolvency issues are addressed in real-world scenarios.

October 2008

Showing: 1 - 3 of 3 Articles
Business Bankruptcy Issues The Financially Troubled Company

Second Liens And Recharacterization: Is More Litigation Around The Corner?

In many Chapter 11 bankruptcy cases, unsecured creditors investigate whether a basis exists to recharacterize existing secured debt as equity. The reason? A successful challenge can turn first or second lien secured debt into "back-of-the-line" capital contributions, enabling unsecured creditors to realize a much greater recovery. A recent article by two of my Bankruptcy & Restructuring Group colleagues at Cooley Godward Kronish LLP, Ronald R. Sussman and Michael A. Klein, digs deeper into the complex issues behind these claims.

Appearing in the October 2008 edition of The Journal of Corporate Renewal published by the Turnaround Management Association, the article is entitled "Recharacterization Battles Likely in Next Round of Bankruptcies." You can access a copy of the article, reprinted with permission of The Journal of Corporate Renewal (© 2008, The Journal of Corporate Renewal), by clicking on its title in the prior sentence. It first discusses the concept of recharacterization itself, including the key factors courts typically apply. Next, the article compares recharacterization to the doctrine of equitable subordination under Section 510(c) of the Bankruptcy Code and examines some of the key differences between the two.

After setting the stage, the article then looks ahead to what appears to be a coming wave of bankruptcy cases. It focuses on how future efforts by unsecured creditors to challenge second lien loans — a type of financing that has become a major part of corporate capital structures over the past several years — may fare:

The next wave of bankruptcies undoubtedly will include attempts by unsecured creditors to recharacterize second lien debt as equity, especially when the second lien holder is an insider of the debtor. However, the current framework established by Bankruptcy Courts presents significant obstacles to unsecured creditors seeking to knock out the second lien claims of lenders that provided capital on a purportedly secured basis to a struggling debtor that was unable to find capital from alternative sources.

The article observes that, given the present state of the law, courts will have to embrace a more flexible legal standard if unsecured creditors are to have success in recharacterizing second lien debt as equity. It concludes by offering a different approach for addressing recharacterization with this new landscape in mind. Unsecured creditors, lenders, insolvency professionals and others confronting these issues will find the article to be a helpful and interesting read.

Business Bankruptcy Issues Recent Developments

The 2005 Bankruptcy Law Changes And Their Impact On Retail Reorganizations

On September 26, 2008, my partner Lawrence Gottlieb, the Chair of the Bankruptcy & Restructuring Group at Cooley Godward Kronish LLP, testified before the Subcommittee on Commercial and Administrative Law of the United States House of Representatives Committee on the Judiciary.  Joining him at the hearing were Professor Jay Westbrook of the University of Texas Law School and Professor Barry Adler of the New York University School of Law. The subject of the hearing was "Lehman Brothers, Sharper Image, Bennigan’s, and Beyond: Is Chapter 11 Bankruptcy Working?" You can access their testimony and watch the full hearing by clicking on the link in the prior sentence.

In his testimony, entitled "The Disappearance of Retail Reorganization In The Post-BAPCPA Era," (a copy of which is available by clicking on its title), he discussed the major impact the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA") has had on retail reorganizations. One of his main observations involves the 2005 amendment limiting the time within which a debtor may assume or reject commercial real estate leases to a total of 210 days (if a 90-day extension is granted). He testified that this change, in combination with other BAPCPA provisions that reduce a retailer’s liquidity, has had a devastating effect on a retailer’s ability to reorganize. Among his comments are the following:

BAPCPA has left retailers without adequate time and money to effectuate operational initiatives and cost cutting measures needed to resuscitate their businesses. Retailers now enter the Chapter 11 arena with little choice but to narrowly tailor their strategy to ensure that their lenders are not deprived of the substantial benefits and protections conferred by section 363(b) of the Bankruptcy Code, which authorizes the use, sale or lease of estate property outside the ordinary course of business upon court approval. Section 363(b) offers the unique ability to cleanse the assets of a distressed company by permitting debtors to convey assets “free and clear,” thereby maximizing value by removing the uncertainty of such stigmas as successor liability, fraudulent transfer claims and lien issues that often accompany asset purchases. Prepetition lenders, cognizant of this powerful liquidating tool and mindful of the numerous liquidity hurdles that the debtor must clear as a result of BAPCPA, have little to gain by risking their collateral in pursuit of a reorganization process now widely perceived as hopeless.

Indeed, the constricted time frames and liquidity problems created and imposed by BAPCPA have effectively eliminated the need for existing lenders to provide any more financing than necessary to position the debtor to liquidate its assets in the first few months of the case. Today, the debtor is no longer “in possession” of its assets or its future upon the commencement of its Chapter 11 case. BAPCPA’s constrictive liquidity provisions and the enormous leverage handed to secured lenders as a result thereof have eliminated the ability of retailers to control the Chapter 11 process as a “debtor-in-possession.” Rather, the process is now controlled almost exclusively by prepetition lenders, who have essentially assumed the role of "creditor-in-possession." 

The Cooley Bankruptcy & Restructuring Group, which Lawrence Gottlieb chairs, is representing official committees of unsecured creditors in high-profile national and regional retail bankruptcies such as Steve & Barry’s, The Bombay Company, Hancock Fabrics, Lillian Vernon, The Sharper Image, Mervyns, Shoe Pavilion, Boscov’s and Goody’s. His testimony, drawing on experience in these recent cases as well as many others in the past, underscores how BAPCPA’s key changes have transformed Chapter 11 bankruptcy from a process by which retailers could reorganize into one where almost all face an early liquidation. Retailers, creditors, and insolvency professionals will find his full testimony on the disappearing retail reorganization both timely and informative.

Business Bankruptcy Issues Recent Developments

The Credit Crisis And DIP Financing

The credit crisis has made it difficult for companies to borrow throughout the economy. It should come as little surprise then that the constriction in the credit markets is hitting Chapter 11 debtors in possession as well. According to an article entitled "Bankruptcy financing gets pricier and more elusive," debtor in possession financing (commonly known as "DIP financing") has recently become more costly for companies in Chapter 11 bankruptcy — when it’s available at all.

  • Adding to the challenge is the amount of prepetition secured financing, including second lien debt, that many companies took on over the past few years when financing was easier to get. A company that has already encumbered its assets with secured debt may have little or no unencumbered assets to offer a DIP lender as collateral.
  • The article predicts that fewer companies in Chapter 11 will be able to find new lenders to provide DIP financing, giving the DIP’s existing lenders the advantage in negotiating DIP financing terms such as interest rate and fees.
  • Alternative sources of DIP financing may be able to be found in certain circumstances. In some cases, the buyer in a Section 363 asset sale may provide DIP financing to bridge to the closing of the sale. However, such limited purpose financing is not a substitute for the type of DIP financing generally needed for a successful reorganization.

Cash is king in bankruptcy and DIP financing is often a key source of that cash. Until the credit crisis subsides and DIP financing becomes more available, companies may find it more difficult to reorganize in Chapter 11.