January 1, 2005

Now that the President has signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, we wanted to take a moment to tell you about a few significant changes that may affect Much Shelist clients. While most of the commentary on the law has been directed at the numerous provisions regarding individuals' bankruptcies, there are a few provisions in the law that affect companies who have or have had transactions with debtors, and individuals who have engaged in estate planning.

  1. Reclamation Demands: The period for making a request for reclamation has been extended to up to 45 days from the debtor's receipt of goods. The law makes clear, however, that a seller's reclamation rights are subject to the rights of a creditor with an existing security interest in such goods. Therefore, even though Congress has extended the reclamation period, the provision continues to have the potential of being a "toothless tiger" for trade creditors. The law recognizes that reclamation creditors may have an allowed administrative expense, which is akin to the priority afforded other expenses incurred by the debtor-in-possession.

  2. Unsecured Priority Wage Claims: The amount of the priority claims for employee's wages, salaries and commissions has been increased to $10,000 from the existing $4,925 cap. In addition, the look-back period for these wages is 180 days versus the current 90 days, prior to the commencement of a bankruptcy case.

  3. Plan of Reorganization: Under the existing law, debtors in chapter 11 may have an essentially limitless exclusive period to file a plan of reorganization and obtain acceptances to their plans. The new law grants the debtors the exclusive right up to a maximum of only 18 months to file a plan following commencement of the bankruptcy case, and two additional months to confirm the plan. The deadlines cannot be further extended by the Court.

  4. Non-Residential Real Estate Leases: Under the current law, the debtor has 60 days from the date the bankruptcy case was commenced to assume or reject an unexpired lease of non-residential property. The new law extends this period to 120 days, generally, from the date the case is commenced. The new law also provides that the debtor is allowed only one 90 day extension over the landlord's objection, after the initial 120 day period expires. All subsequent extensions must be with the landlord's written consent. As an accommodation to the unwilling landlord who finds their property subject to a 210 day tenancy by the debtor-in-possession, the law creates a specific administrative expense provision for payment of the landlord's post-petition claim.

  5. Preference Actions: The "ordinary course of business" defense to preferential transfers has been revised so that a creditor can defeat the lawsuit by proving that the payments at issue were made according to the ordinary course of business as between the debtor and the creditor, even if the industry standard is different. Alternatively, the transfers may be defendable if they were made according to ordinary course of business terms as those terms are defined by industry standards.

  6. Venue of Certain Actions: Under the new law, no lawsuit may be filed to recover a preferential transfer unless the amount sought to be recovered is greater than $5,000. The current law has a $600 threshold. Also under the new law, lawsuits to recover preferential transfers (or any action by the trustee to recover a money judgment) of less than $10,000 must be filed in the district court for the district where the defendant is located.

  7. Preference Action Against a Creditor Holding Personal Guarantee of Insider: Under the existing law a trade creditor who received a payment between 90 days and one year of the commencement of a bankruptcy case, and who held the personal guarantee of an insider of the debtor ran the risk of being placed into the shoes of the insider with an expanded preference period of one year. Under the new law, only the insider may be subject to the recovery or avoidance of such transfer.

  8. Fraudulent Transfers: The new law enables the trustee to reach back two years prior to the filing of the bankruptcy case (under Federal Law) to recover fraudulent transfers, rather than one year under existing law. The new law also clarifies a trustee's right to recover any transfer to or obligation incurred for the benefit of an insider under an employment contract under certain conditions.

  9. Expanded Grounds for Dismissal or Conversion and Appointment of Trustee in Chapter 11 Case: The new law provides a non-exhaustive list of 16 factors that may be a basis for finding cause necessary to dismiss a Chapter 11 case, convert a Chapter 11 case to a case under Chapter 7 or to appoint a trustee or examiner in a Chapter 11 case.

  10. IRAs: The new law provides that retirement accounts that are tax exempt under the Internal Revenue Code are exempt from the debtor's bankruptcy estate without regard to whether the debtor elected state or federal exemptions. The new law, however, now imposes a $1,000,000 limitation (to be adjusted for inflation) on traditional IRA and Roth IRA earnings and contributions (even if state law does not contain such a limitation). However, this $1,000,000 limitation does not apply to rollover contributions from a qualified plan. As a result many individuals with large IRAs will not be affected by this limitation.

  11. Homestead Exemptions: Are now capped at $125,000.

  12. Tuition Programs: The new law also provides for exclusions of funds placed in qualified state tuition programs as well as to postsecondary education savings through IRAs and 529 plans for the benefit of a child, stepchild, grandchild or step-grandchild of the debtor more than 364 days before filing for bankruptcy. All funds contributed more that 720 days before filing are protected, while protection for funds contributed between 365 days and 720 days before the filing are limited to $5,000 per beneficiary, and no protection is afforded for contributions within 364 days before filing.

  13. The Effective Date: Some provisions of the law are effective immediately to pending cases. Other provisions are effective 6 months after enactment of the law, while still other provisions are not effective until 18 months from enactment. Consequently, you could be sued for a preferential transfer a year or two from now in a bankruptcy case that is currently pending, or one that is filed within the next six months, and not get the benefit of the changes in the ordinary course of business defense.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.