|Business Credit Articles|
After much negotiation, you finally have an allowed administrative claim for your reclamation claim as your major customer's Chapter 11 plan of reorganization is finally confirmed. The plan of reorganization provides for the customer to continue to operate, albeit with significantly less debt. Your administrative claim comes at a price, as you agree to ship on credit to the 'reorganized' debtor post-confirmation. Your company anticipates resuming significant sales to the reorganized debtor and supports resumption of credit terms.
The payment on your reclamation claim is over time, based on the reorganized debtor's cash flow. Payment on a percentage of your mid-six figure claim is also to be over time. Your company also receives stock in the reorganized debtor in exchange for its pre-petition claim.
Notwithstanding all of the projections prepared by the debtor's accountants to confirm the plan of reorganization demonstrating the debtor would be profitable, it is not. Projections are missed and the debtor fails to pay on your administrative claim. The debtor also fails to pay on your post-confirmation credit sales. The debtor is chased by creditors and files a second Chapter 11 bankruptcy. How can this be? May a company file a second Chapter 11, also referred as a Chapter 22? Your major customer had spent two years in Chapter 11 and several million dollars on its attorneys, accountants and investment bankers to assist in paring down creditors' pre-bankruptcy debts, disposing of certain assets and repositioning itself in the marketplace.
Your customer had circulated a hundred-plus page disclosure statement and plan of reorganization to all of its creditors, supported by the creditors' committee and the bank group, coupled with pages of financial projections prepared by the debtor's Big 5 accountants detailing how the 'new and improved' reorganized debtor would meet its trade obligations and return to profitability. The bankruptcy court found the plan of reorganization 'feasible' and blessed the plan. You now realize that a confirmed Chapter 11 plan of reorganization, even supported with detailed projections showing your customer profitable, does not guarantee payment on your pre-Chapter 11 debts nor on your new shipments. What now?
A number of companies have made headlines recently for their second Chapter 11 case, such as Montgomery Wards, Bradlee's and LTV Steel Corporation (which was a Chapter 11 debtor for seven years), and a number of companies are rumored in the press to be considering similar action.
Many of these reorganized debtors are in industries with strong competition that could not meet their debt obligations and were forced again into Chapter 11 by their creditors. Notwithstanding years in Chapter 11, the extraordinary benefit of generally not paying pre-bankruptcy creditors, and a negotiated plan of reorganization that was supported by detailed projections of how the reorganized debtor would be profitable, such companies often failed to pare down their debt sufficiently in the first Chapter 11.
These companies defaulted on their confirmed plan of reorganization, and post-confirmation debts, followed by the filing of a second bankruptcy petition to obtain the automatic stay (an injunction that arises automatically upon the filing of the petition that enjoins creditors from collecting on their pre-petition claims) and a second opportunity to pare down their debts, and a likely orderly liquidation of the debtor's assets.
A vendor that has provided goods or services to these companies during the first Chapter 11 case, or after these 'reorganized' companies have emerged from Chapter 11, likely face a write-off of their open account with the second Chapter 11 filing. The problem is that a company which has spent a number of years in Chapter 11 and confirmed its operating plan of reorganization, and some time out of it, may pose complex legal questions in determining which assets are part of the new bankruptcy estate, which claims may be entitled to priorities, and which transactions may be recovered under the avoidance powers created under the Bankruptcy Code, all of which may waste the assets available to pay vendors. The recent trend of some companies willingness to file a second Chapter 11 raises new questions-and poses new risks- regarding a vendor's strategy of credit sales to a company that is presently in Chapter 11, as well as one that has emerged from Chapter 11 (even years afterwards). A vendor may also questions whether it should accept payment on a reclamation claim over time in exchange for credit sales.
The Confirmed Chapter 11 Plan Does Not Guarantee Payment On Future Shipments
The primary purpose of a Chapter 11 case is the negotiation between a debtor and its creditors of a plan of reorganization which restructures the debtor's finances, provides the basis for repaying creditors and is the gateway through which a debtor emerges from Chapter 11. While a plan of reorganization takes many forms, typically the plan provides the company to continue to operate and pay vendors on their pre-petition claim over time. The confirmation of the plan bars vendors from pursuing their pre-confirmation claims and these claims are discharged and replaced by the new obligations specified in the plan. When the court confirms a plan of reorganization, it makes a determination that the plan is 'feasible'; e.g. that the company is capable of meeting its obligations under the plan.
With large operating companies with many tiers of debt, determining whether a plan is feasible may take several days of testimony from financial experts. However, as the recent press reports indicate, confirmation of a Chapter 11 plan does not mean that vendors will be repaid according to the terms of the plan or that vendors furnishing goods on credit post-confirmation will not face bankruptcy risk. Once a plan of reorganization is 'substantially consummated' (fully completed), it cannot be altered or amended absent a showing of fraud. Ordinarily, substantial consummation occurs when the plan goes into effect.
Bankruptcy Courts Generally Don't Bar Second Chapter 11 Filings
The Bankruptcy Code does not expressly bar a company from filing a second Chapter 11, unlike an individual who files a Chapter 7 liquidation and obtains a discharge (which individual is barred from refiling for five years). Notwithstanding the Bankruptcy Code's absence of a bar on Chapter 22, bankruptcy courts that first faced whether an enterprise that filed a second Chapter 11 are eligible generally dismissed the case, forcing the reorganized debtor to liquidate its assets under the confirmed plan or convert to Chapter 7 liquidation.
These courts expressed concern that permitting debtors to file a second Chapter 11 was an attempt to circumvent the claims of the creditors who had participated in the first Chapter 11. These courts also expressed concern that allowing a debtor to circumvent the provisions of a confirmed plan could dissuade creditors from working with a financially strapped debtor, especially those that had furnished goods on open account during the Chapter 11. These courts noted a second plan, if confirmed, could discharge the obligations created in the first plan, including priority claims, and the potential loss of priority status in the second case could dissuade creditors from providing post-petition trade credit.
The modern trend of bankruptcy courts, however, is to permit a company to file a second Chapter 11 petition, as opposed to forcing the company into an involuntary dismissal of the bankruptcy petition or conversion to Chapter 7 liquidation. These courts reason that the costs and creditors involved benefit more from a second Chapter 11 filing, than liquidation alternatives under Chapter 7 or state law. Often the two Chapter 11 filings are for different purposes, with the first Chapter 11 filing intended to reach a consensual plan of reorganization, while the second Chapter 11 filing is for a partial, or complete, liquidation of the company, with assets sold off to satisfy the secured creditor. While courts recognize the concern that vendors may sell on credit post-confirmation if there is perceived a risk of a second filing, courts refuse to dismiss a case on these grounds.
Risks Posed to the Vendor
As recent press reports indicate, even if an enterprise confirms a plan of reorganization that proposes to pay vendors overtime, there is no guarantee the enterprise will still not return to financial straits and file a second Chapter 11. Vendors may be at risk under this recent trend. For debtors and creditors to cooperate in Chapter 11, Congress saw fit to maintain checks and balances between the parties. This is done, in part, by granting vendors that sell post-bankruptcy on credit a higher priority of payment than pre-petition unsecured creditors, should a debtor fail to pay. A second Chapter 11 may strip the vendor of this priority.
Likewise, the filing of a second Chapter 11 poses special risks to pre-petition unsecured vendors that are offered under the first plan of reorganization terms that allow vendors a more favorable payment on their unsecured claims should they supply the debtor on credit after the plan is confirmed. A second Chapter 11 filing would treat these post-confirmation credit sales to the same priority status as other unsecured creditors. The willingness of companies to file a second Chapter 11 also raises the question of whether vendors should negotiate during the first Chapter 11 for payment terms under the plan of reorganization that excludes the payment of stock and instead press for payment in the form of a note. While vendors may seek stricter provisions in a Chapter 11 plan governing the liquidation of the debtor in the event of a post-confirmation failure, in reality a second filing would wipe any stricter provisions.
The recent trend of companies' willingness to file a second Chapter 11 poses new risks to the credit professional. Perhaps the strongest reminder for the credit professional is that notwithstanding a reorganized or reorganizing company's assurances, supported by statements and projections prepared by its financial consultants that it has restructured its balance sheet, shed its unproductive assets and repositioned itself in the marketplace, there is the risk of a second Chapter 11 filing. Recognizing this, a credit professional may reevaluate whether credit should be extended to these companies, both during and after Chapter 11.