Execsense powerpoint Warren J. Martin Jr. Attorney

Bankruptcy Law Basics and Best Practices for Corporate Lawyers
Warren J. Martin Jr., Porzio, Bromberg & Newman, P.C.
www.pbnlaw.com
Bankruptcy Law Basics
and Best Practices for
Corporate Lawyers
Material in this seminar is for reference purposes only. This seminar is sold with the understanding that neither any of the authors nor the publisher are engaged in rendering legal, accounting, investment, or any other professional service directly through this seminar. Neither the publisher nor the
authors assume any liability for any errors or omissions, or for how this seminar or its contents are used or interpreted, or for any consequences resulting directly or indirectly from the use of this seminar. For legal, financial, strategic or any other type of advice, please personally consult the
appropriate professional.
Warren J. Martin Jr. Porzio, Bromberg & Newman, P.C.

www.pbnlaw.com
Overview
This one-hour presentation will be divided into four
areas of interest to corporate lawyers:
1. Overview of Bankruptcy Basics;
2. Bankruptcy 363 Sales and Bankruptcy Plan Sales;
3. Structuring Transactions to “Avoid Avoidance;” and
4. Considerations of Alter Ego/Piercing the Corporate
Veil/Substantive Consolidation/Extension of Proceedings.
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I. Overview of Bankruptcy Basics
A. Goals/Policy of Bankruptcy Law:
1. Breathing Spell. 11 U.S.C. §362
2. Fresh Start. 11 U.S.C. §1141
3. Equitable Division of Assets. 11 U.S.C. §1129; §726
4. Assets are more productive/valuable when they remain
engaged in the stream of commerce. Chapter 11 seeks to
restructure a business’ finances so it can continue to
operate, provide employment and pay creditors. 11 U.S.C.
§§1107, 1108
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B. Bankruptcy Law is:
1. Federal Law
2. Paramount to and Supersedes Inconsistent State Law
3. However: Butner v. U.S., 440 U.S. 48(1979) – Property Rights
in Bankruptcy are Determined Under State Law, e.g., (i) Is
the Lien Properly Perfected? (ii) Does the Debtor Own the
Asset?
I. Continued…Overview of Bankruptcy Basics
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C. Types of Corporate Bankruptcy Cases
1. Chapter 7 – Liquidation
– Liquidate and distribute proceeds to creditors
according to the priorities established under the
Bankruptcy Code
2.Chapter 11 – Reorganization
– Propose and confirm a plan for repayment of debts on
terms more favorable to the Debtor than was required
by the Debtor’s pre-petition contracts
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D. How Does a Bankruptcy Proceeding Start?
1. Voluntary Petition – Constitutes an “Order for relief”
a. Schedules/Statement of Financial Affairs
b. Insolvency not Required
2. Involuntary Petition - not an “Order for relief”
a. Different Requirements Depending on Number of
Creditors
b. Insolvency Required if Contested
c. Potential Liability to Petitioners if Petition Dismissed
and Bad Faith Found
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E. Chapter 11 - Reorganizations
1. Key Terms
a. Debtor-In-Possession – Upon a chapter 11 bankruptcy filing, the
existing management of the company remains in control and makes
the decisions for the chapter 11 debtor during the proceedings.
b. Disclosure Statement – A written document prepared by a chapter 11
debtor or other plan proponent designed to provide “adequate
information” to creditors to enable them to evaluate the chapter 11
plan of reorganization.
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d. Plan – A debtor’s detailed description of how the debtor
proposes to pay creditors’ claims over a fixed period of
time.
e. Confirmation – Bankruptcy judge’s approval of a plan of
reorganization or liquidation in chapter 11.
f. Creditors’ Committee – A group of unsecured creditors
who are chosen by the U.S. Trustee’s Office to represent the
interests of all general unsecured creditors.
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F. Chapter 7 vs. Chapter 11
1. Chapter 7 – Liquidation
a. Mandatory appointment of a trustee
b. Trustee marshals and liquidates assets of business and distributes the
proceeds to creditors in accordance with statute
c. Continued operation of a business (if at all) is only temporary, 11 U.S.C.
§721
2. Chapter 11 – Reorganization
a. Debtor retains, manages and operates assets as a debtor in possession
(“DIP”), subject to certain enumerated restrictions, e.g., 11 U.S.C. §§363,
364, 365, 366, etc…
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b. A trustee is only appointed for “cause” including fraud or
gross mismanagement by the debtor.
c. Chapter 11 reorganization plan can modify the capital
structure of the debtor and the payment terms of all
obligations. All remaining financial obligations
incorporated into the plan of reorganization.
d. Liquidation is also permissible in a chapter 11 case, of ten
times through §363 sales. Chapter 11 permits orderly
sales with DIP in control as opposed to fire sales
conducted by trustee.
I. Continued… Overview of Bankruptcy Basics
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G. Automatic Stay – 11 U.S.C. §362
1. Stays:
a. Commencement or Continuation of Judicial Proceeding or Other Acts to
Collect Pre-Bankruptcy Claims
b. Performance of any act to obtain possession of or create, perfect or enforce
a lien against property of estate
2. Benefits:
a. To Debtor
b. Ends Competition Among Creditors to Achieve Goal of Equality of
Distribution
3. Exceptions to Automatic Stay, e.g., Police Powers
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H. Strong Arm Provisions - 11 U.S.C. §544
1. “Arms” Trustee/DIP With State Law Avoidance Powers
a. Hypothetical Judgment Lien Creditor status:
Allows avoidance of unrecorded or improperly recorded
financing statements on personal property;
b. “Bona Fide” Real Property Purchaser status:
Allows avoidance of unrecorded or improperly recorded
mortgages on real property.
2. Utilize State Law Reachback Period
3. State Law Fraudulent Conveyances, e.g., NY – 6 years
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I. Claims Process
1. Proof of Claim
a. Unsecured
b. Secured
c. Priority
2. When to File
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J. Voting Process
1. Disclosure Statement (DS)
2. DS, Plan and Ballot
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K. Structure of Plan Classes/Creditor Voting
1. Don’t Need All Classes to Vote in Favor
2. Don’t Need All Creditors Within Each Class to Accept
a. More Than Half in Number
b. At Least Two-Thirds in Amount
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II. Bankruptcy 363 Sales
A. Sales Pursuant to Chapter 11 Plans Confirmed Under §1129
1. Sale is part of the overall restructuring
accomplished after a full disclosure and solicitation
process.
2. The sale can be done in connection with new financing,
issuance of new securities, the fixing of tax claims and
the provision of full releases in favor of all parties involved
in the plan process.
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B. 363 Sales
1. Can you sell all or substantially all of an operating business
without a plan?
✤ See Lionel and Braniff decisions
✤ See Chrysler, GM, and Lehman Brothers cases.
✤ Legal standard business judgment test, fair value and no
undisclosed “side deals”, In Re Abbots Dairies.
II. Continued… Bankruptcy 363 Sales
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C. COMPARISON 363 SALES VS. PLAN SALES
363 Sales Plan Sales
*Ordinary APA is used *Sale is incorporated into the Plan
(although an APA will likely be used as
well)
*Lightening Fast 45-60 Days *Plan slow – 6 months
*Sale subject to “higher and better” *Easier to limit the sale to a particular
offers buyer/transaction
*Some successor liability protection *Much fuller releases and adjudications in
can attempt to be built into the sale connection with confirmation of the Plan.
order
*Transfer tax relief under section 1146
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D. Procedures For 363 Sales
1. Typically a debtor proceeds with a stalking horse bidder and
approaches the Court with a stalking horse contract and proposed
bid procedures order.
2. Bid procedures order could include the following protections:
a. breakup fees or expense reimbursements if stalking horse is unsuccessful
b. minimum overbid requirements
c. qualification requirements for competing bids and competing bidders
d. accelerated due diligence/auction process
e. requirement that the stalking horse bidders’ form of APA be used
f. Require bids to be irrevocable
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3. All of these are designed to put the stalking horse bidder in an
advantaged position.
4. These buyer protections must be approved in advance at a
hearing on the bid procedures order. Objections may be filed
and the Court will decide whether or not these protections
unnecessarily “chill” the bidding.
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E. Court Approval of The Sale
1. Determination of which bid is the “highest and best.”
2. Closing immediately if automatic 10 day stay of sale order is
waived or as early as the 11th
day if not waived.
3. Mootness: §363(m) provides that if the sale is found to be in “good
faith” the sale cannot be reversed on appeal, even if the appeal is
successful.
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F. Sales are “Free And Clear”
1. Pursuant to §363(f) the sale is free and clear of all liens, claims and
interest if:
a. The price paid is greater than the aggregate value of all liens on
the property.
b. The lien/interest is in bona fide dispute.
c. Applicable non bankruptcy law permits the sale of such property
free and clear of such interest.
d. The creditor/interest holder could be compelled, in a legal or
equitable proceeding, to accept a money satisfaction of such
interest.
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G. Assumption of Executory Contracts and Leases
1. The buyer may generally select contracts to be assumed and
force the rejection of other contracts and leases not desired by
the buyer.
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A. Avoiding Powers
1. Who has Standing: Trustee, Debtor-In-Possession,
Derivative Standing (Creditors’ Committee), Litigation
Trustee
2. Philosophy:
a. “Roll back” the petition date – preferences
b. Reverse unfair transactions – fraudulent conveyances
c. Increase Size of Estate For Benefit of All Creditors
III. Structuring Transactions To “Avoid Avoidance”
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B. Preferences
1. A transfer;
2. To or for the benefit of a creditor;
3. For or on account of an antecedent debt;
4. Made while debtor was insolvent (rebuttable presumption of
insolvency within 90 days of the petition date);
5. Made within 90 days of the petition date; and
6. Which enables the creditor to receive more than it would have
received if the transfer had not been made and the debtor was
liquidated at the time of the transfer.
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III. Continued…Structuring Transactions To…

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C. Preference Defenses:
1. Contemporaneous Exchange for Value – the payment was
received contemporaneously in exchange for goods (e.g., CBD
or COD)
2. New Value Exception – the creditor provided subsequent new
value for which it was not paid
3. Ordinary Course of Business Exception – payment was made in
the ordinary course of business or made according to ordinary
business terms (e.g., debtor generally paid on net-30 terms and
all payments made within the 90 day preference period were
net-30 days)
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D. Fraudulent Transfers - 11 U.S.C. §548 and 11 U.S.C. §544
Bankruptcy Code permits debtor to void certain transfers made
within 2 years (548) and up to 4-6 years (544) under state law
where:
1. Actual Fraud
2. Constructive Fraud – 3 part test
a. Transfer
b. Less than reasonably equivalent value and
c. Financial Requirement
i. Insolvent/rendered insolvent
ii. Unreasonably small capital
iii. Leave debtor with debts beyond ability to pay
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E. “Preference Proofing” Settlements Practice Tip:
1. Don’t reduce the claim until the 91st
day following receipt of the funds.
2. Example: If $10MM debt compromised for $5MM, paid in 10 monthly
installments of $500K, provide for the payments but do not compromise the
debt for $5MM. Instead, provide simply that the $10MM is discharged on
the 91st
day following the final payment (i.e., in the 14th
month).
F. “Preference Proofing Payments - - Earmarking Doctrine:
1. Money provided by a third-party source who “earmarks” the funds to be
used only to pay your client’s claim. Debtor can have no
authority/discretion over the funds.
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G. “Preference Proofing -- “Mere Conduit”
1. If the recipient of the otherwise preferential payment is simply a pass-through
entity but not the beneficial recipient of the payment there will be a common
law “mere conduit” defense.
H. Collateralizing Antecedent Debt
1. While such transactions are generally exempt from fraudulent conveyance
exposure, the collateralization of previously unsecured debt within 90 days of
a bankruptcy will generally be preferential.
Avoiding Avoidance - - Get:
a. a solvency opinion, or
b. an opinion that if the company were liquidated, you would receive more than
the value of the collateral you are receiving under the settlement.
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I. The Best Preference Proofing Fraudulent Conveyance
Protection:
1. If it’s a big enough transaction, do the transaction within
a chapter 11 or an Assignment for the Benefit of
Creditors (ABC). This also offers close to absolute
protection from fraudulent transfer exposure.
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J. Fraudulent Conveyance Horror Story: ASARCO
• In March of 2003, Asarco apparently suffering from solvency concerns, sells
its 54% stake in Southern Peru Cooper (“SPC”) to Asarco’s own parent, Grupo
México (“Grupo”) , for $765 million.
• The assets were worth $1.1 billion at the time of the transfer.
• On August 9, 2005, Asarco seeks Chapter 11 relief.
• On February 2, 2007, Asarco brings claims against Grupo seeking to avoid the
transfer of SPC stock as a fraudulent conveyance.
• Not content to provide money damages, the court ruled that the transfer of
the SPC stock was a fraudulent conveyance and that the appropriate remedy
under §550 of the Bankruptcy Code is to require return of the fraudulently
transferred property.
• The transferred stake in SPC as of the date of the Court’s judgment is
estimated to be worth $6 billion.
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K. Avoid Asarco’s Horror Story
1. Obtain a VALID solvency opinion from a reputable CPA firm at the
time of the transfer.
2. Obtain a VALID fair market value opinion from a reputable
appraiser/investment banking firm that the price paid is fair value
for the assets transferred.
3. Pay fair value! The $300 million discount Grupo thought it
received ultimately cost it $6 billion.
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• Undercapitalization
• Failure to observe corporate formalities
• Hopelessly intermingled assets and liabilities
• Failure to keep adequate books and records
• Actions/appearances that lead vendors/creditors into
believing they are dealing with a single entity
IV. Alter Ego/Piercing the Corporate Veil/
Substantive Consolidation/Extension
of Proceedings
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A. Instances where it arises:
1. Parent/Sub (piercing)
2. Affiliate, direct or indirect
(a) substantive consolidation/extension of proceedings.
IV. Continued… Alter Ego, etc…
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B. How to successfully separate out assets of one from the
other? (Besides not doing things listed on slide #30)
1. Conduct the transaction within a bankruptcy proceeding
2. Conduct the transaction within an Assignment for the
Benefit of Creditors (ABC) proceeding
3. Obtain VALID opinions as to appropriate capitalization/
solvency at the time of the transaction
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C. Case Study Extension of Proceedings
1. In re G-1, Building Materials Corporation of America
(“BMCA”)
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