Business Bankruptcy–Operating During Administrative Period

Business Bankruptcy – Simplified Operating Guidelines

A "How-To" Manual

For Non-Bankruptcy Professionals
Page 5
Robert S. Apfelberg, Karrie L. Bercik, Esq.

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Chapter 3. Operating During the Administrative Period

A. Ordinary Course of Business

During a chapter 11 the debtor’s management does not have to seek bankruptcy court approval to operate its business in the customary manner ("ordinary course of business"). Although operations are subjected to enhanced scrutiny and reporting requirements, bankruptcy court approval is only required for those activities "outside" the ordinary course of business. Some examples are: (i) settling any substantial claim or litigation, (ii) obtaining new credit, (iii) purchasing or selling equipment, old inventory and product lines, (iv) changes in senior management, or (v) leasing property or terminating leases. It is advisable to conservatively categorize changes as outside the ordinary course of business.

B. The Unsecured Creditors Committee

The United States Trustee ("U.S. Trustee") is different from the trustee-in-bankruptcy ("trustee"). The U.S. Trustee is a part of the United States Department of Justice, ("Department of Justice") and is an interested party in every bankruptcy. The Office of the United States Trustee ("OUST") is the operating staff of the U.S. Trustee. They will determine the size and members of the unsecured creditors committee, typically, from the twenty largest unsecured creditors. Each group of creditors with similar interests will be placed into a group ("class") for the purpose of the bankruptcy. An example of typical classes are: (i) secured lenders, (ii) equipment lessors, (iii) landlords, (iv) trade suppliers/unsecured creditors, (v) employees, (vi) bondholders, and (vii) equity holders.

The unsecured creditors committee has a fiduciary obligation to all of the unsecured creditors and may have almost as much power as a secured creditor. The committee is also specifically given a great deal of oversight responsibility, including the authority to: (i) investigate and audit the financial condition, operations and acts of the debtor, (ii) request the appointment of a trustee, (iii) request the appointment of a bankruptcy examiner ("examiner") who will be given power over, and the right to audit, the debtor, and (iv) help create the plan of reorganization. The debtor’s management should maintain a cooperative relationship with the unsecured creditors committee and its counsel.

C. Bank Accounts

Immediately upon filing the chapter 11 petition the debtor must close all of its old bank accounts and open new ones denominating itself as a debtor-in-possession and listing the case number. Separate general, payroll and tax accounts will be required, but other types of customary accounts are allowed (postage, trust, commission, license, fees, etc.). Immediate notice and explanation should be given to the holders of checks written on the closed accounts since they will bounce and cannot be replaced.

D. Executory Contracts

An "executory contract" is generally defined as one where both parties must substantially perform in the future. Leases, collective bargaining agreements, employment contracts and supplier contracts are typical executory contracts. The debtor may "assume, assume and assign, or reject" executory contracts.

If an executory contract is "assumed" during the administrative period then the other party to the contract becomes an administrative period creditor granted priority payments over most pre-petition creditors ("administrative priority").

The debtor may "reject" the contract, give up its benefits, and the other party becomes a pre-petition unsecured creditor for any contractual damages. If the rejected contract is a non-residential lease, the "rejected" landlord’s claim cannot exceed the greater of: (i) one years rent, or (ii) fifteen percent of the remaining term of the lease, but not to exceed three years. This can be used as an effective tool in landlord negotiations, particularly where unsecured creditors receive a small percentage of the dollar amount of their claim.

The debtor may "assume and assign" an executory contract, usually upon a sale of the company or a portion of its: stores, machinery and equipment, etc. However, to assume and assign, the executory contract can have no pre-petition or administrative period arrearages and the assignee’s credit must be pre-approved by the other party to the contract.

Executory contract creditors would prefer to quickly know whether the debtor will assume, assume and assign or reject their contract. Generally, the debtor can wait until confirmation of a plan of reorganization to assume, assume and assign or reject executory contracts, unless they are for non-residential real estate.

A non-residential real property lease must be assumed or rejected within sixty days of filing the petition ("assumption period"). The bankruptcy court usually will extend the assumption period for good cause, over the objection of the lessor. However, any extension must be obtained prior to the end of the initial sixty days, or any extended, assumption period.

E. Insider Payments

Senior managers, shareholders, or any of their family members, ("insiders") cannot be compensated as employees without filing and serving a "request for insider compensation" and individually obtaining bankruptcy court approval. Insider wages may be accrued, but not paid, during the approximately twenty-one day "notice and objection" period. The insider must disclose its name, social security number, relationship to the debtor, duties and responsibilities, prior compensation, future compensation and where the company will obtain the funds to pay their wages (typically operating funds). Creditors may object to these wage payments. Insiders owed payments for other reasons (loans, leases, or acting as a trade supplier) should also be disclosed. Any payment to an insider will be the subject of careful scrutiny (and resentment) by other interested parties.

F.  Insurance and Utilities

Utilities (electricity, gas, water, telephone, internet, paging, etc.) providers will typically demand a deposit to provide administrative period utility services. Often the deposit required is equal to twice the highest previous monthly bill. Although it is impractical, the debtor may seek court approval for a lower utility deposit.

The debtor must convert, or obtain, insurance coverage in the name of the debtor-in-possession. This may include: all risk property and casualty, automobile, director and officer liability, errors and omissions, and products liability, etc. All of the debtor’s assets, employees and potential liabilities must be insured in a customary manner.

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