While risking the faux pas of a sweeping generalization, it is probably safe to say that most chapter 11 debtor attorneys frame their first-day motions around previously successful forms. This holds especially true for motions that are routinely granted and rarely (or at least less frequently) disputed, such as motions for continued utility service, approval of key employee/executive retention plans (KERPs) and retention of professionals.

With the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a number of new rules will mandate careful updating of a variety of common first-day papers used in cases filed on and after Oct. 17, 2005. Depending on the particular circumstances of each new case, certain of these changes may significantly affect the debtor's post-petition liquidity, day-to-day management and viability as a salvageable going concern.

Tougher Standards for Utility Service Protection: §366(c)

Under the "old" Code, a motion under §366(b) to prohibit utilities from disconnecting service after the first 20 days of the case was one of the most innocuous and overlooked of first-day papers. This was largely because the former §366(b) enabled the debtor to sidestep having to furnish a cash deposit as "adequate assurance of payment" by moving for a "reasonable modification of the amount of the deposit or other security...."¹ This "reasonable modification," courts held, could be as little as a representation that the debtor had sufficient financing to pay post-petition bills, or that affected utilities would be afforded administrative expense claims for any unpaid post-petition charges.²

But "adequate assurance of payment" under revised §366 is substantially more burdensome for the debtor because the "reasonable modification" language has been limited by a new §366(c), which strictly requires either a cash deposit, letter of credit, certificate of deposit, surety bond, prepayment or any other form of security that is "mutually agreed" upon by the debtor and the affected utility. Under new §366(c)(3)(A), the debtor still has the right to move for a modification of the amount of adequate assurance, but new §366(c)(1)(B) specifically excludes provision of administrative priority as an allowable means of the required security.

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As painful as it may be...practitioners entrenched in first-day forms of the past should heed the measurable breadth of the changes to the Code and start familiarizing themselves with the new provisions...sooner rather than later.

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These enhanced security requirements, while perhaps appearing harsh, arguably follow the time-tested adequate protection standards of §361. Consider, for example, §361(3), which specifically prohibits administrative expense provision as a mode of adequate protection. In any event, this change is sure to register with debtors who have substantial utility usage requirements or first-day liquidity concerns.

KERPs Face High Threshold

To the extent the "E" in "KERP" means "executive," saying that the KERP approval process has been turned upside down under new §503(c) would be putting it lightly. The entirely new §503(c)(1) prohibits payments to an insider (i.e., an executive) of the debtor absent an evidentiary finding that (1) the payment is "essential to the retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation"³ and (2) the services provided by the insider are "essential to the survival of the business...."⁴ In addition, executive retention payments are capped by §503(c)(1)(C), which limits payments at either (1) 10 times the amount of the "mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose"⁵ during the calendar year in which the payment is made or (2) if no similar payments were made to non-management employees during the same calendar year, 25 percent of any similar payment given to the executive in the prior calendar year.⁶

New §503(c)(2) imposes similar formulaic restrictions on severance payments to insiders: The payment must be "part of a program that is generally applicable to all full-time employees,"⁷ and the amount of the payment may not exceed 10 times the amount of the mean severance pay given to nonmanagement employees during the same calendar year in which the severance payment is made.⁸

By comparison, these facially onerous revisions are bound to make the old KERP approval process seem like a free-for-all. Formerly, KERP motions could be rooted successfully in the courts' rather loose, catch-all interpretations of §§105(a) and 363(b) (i.e., approval of a KERP is an appropriate exercise of the court's broad equitable powers because it is a justifiable, non-ordinary-course "use" of property of the estate).⁹ But the new rules mean that those tried-and-true form KERP motions will be condemned to the circular file. This holds especially true for the painfully straightforward "bona fide job offer" mandate of §503(c)(1)(A), which, on its face, will render a firm job offer an absolute prerequisite to KERP approval. Since "bona fide" executive pavement-pounding can take months or more, debtors counting on first-day KERP approvals would be remiss not to heed these amendments carefully and early.

New Procedures for Sales of "Personally Identifiable" Consumer Data¹⁰

Revised §363(b)(1) exemplifies the "consumer protection" undercurrent of the new reforms, at least as far as the nonconsumer sections of the Code are concerned, by adding special procedural requirements for conducting sales of "personally identifiable" consumer information.¹¹ Under new §363(b)(1), if the debtor has disclosed to an individual a "policy prohibiting the transfer of personally identifiable information [to unaffiliated third parties],"¹² the sale cannot be approved unless either (1) the transfer of the data is deemed consistent with the disclosed policy¹³ or (2) the court finds, after appointment of a "consumer privacy ombudsman" under new §332, that the sale would not "violate applicable non-bankruptcy law."¹⁴

Entirely new §332 empowers the U.S. Trustee to appoint a consumer privacy ombudsman in advance of a §363(b) hearing involving the transfer of personally identifiable information to act, essentially, as a class representative for potentially affected consumers (or perhaps, in practical application, even a mini-U.S. Trustee). Under §332(b), the ombudsman is charged with "assist[ing] the court" in its evaluation of the proposed sale of personally identifiable information and is granted standing to appear at the sale hearing and present evidence of the pros and cons of the sale, as well as possible alternatives to the sale, among other rights and duties. Inevitably, the §363 sale process will have a new player to contend with when consumer data is on the table.

These revisions will affect only a fraction of §363 sales, but nevertheless should have a measurable impact in cases with any connection to consumer retailing. Moreover, while it goes without saying that §363 motions are not necessarily or typically first-day motions, there is bound to be a marked upswing in prepackaged §363 deals that necessitate sale and bid procedure filings on or shortly after the petition date. This would be a logical byproduct of the coupling of the new Code's significantly abbreviated timeframes for plan exclusivity¹⁵ and non-residential real estate lease rejections¹⁶ with the general upward trend in §363 sales.

Employment of Investment Bankers Relaxed

The definition of "disinterested person" in §101(14) has been substantially revised to eliminate the restriction on pre-petition investment bankers (and their attorneys). Inasmuch as §327(a) mandates that estate professionals be "disinterested" as an absolute condition of employment, this change should prove especially fruitful for investment banks and financial consultants who might otherwise have been turned away because of a pre-petition relationship with the debtor.

Under former §101(14), an investment bank could not be "disinterested" if it was involved with the offer, sale or issuance of the debtor's securities (at any time for outstanding securities or within three years of the petition date for any other securities). These impediments have been wiped out under new §101(14), however, which has been substantially truncated to restrict only the broader, traditional categories of ineligibles: insiders, creditors, equity-holders and the like.

In many cases with ambitions for prepackaged asset sales or third-party sponsored plans, this revision should streamline the chapter 11 transition, at least insofar as debtors will be able to preserve valuable continuity in the professional supervision of the underlying (and largely unavoidable) marketing and competitive bidding processes.

Other First-day Matters

Reclamation procedures motions—which typically focus on the imposition of various evidentiary ground rules and deadlines as a vehicle for quietly thinning the unwary reclamation herd—will require subtle updating under the amendments to §§546(c) and 503(b). New §546(c)(1) expands the look-back period for reclamation claims to 45 days (upon timely notice to the debtor). Also, in conjunction with new §503(b)(9), §546(c)(2) grants reclaiming creditors the right to seek an administrative expense claim for goods received by the debtor within 20 days of the commencement of the case, even if the creditor fails to make a timely reclamation demand. While these revisions should not substantively impact most commonly sought reclamation procedures, the revised look-back periods should be observed and incorporated in post-effective date motions.

Also, with the expansion of priority employee claims under new §507(a)(4) (formerly §507(a)(3) and already effective), first-day motions for authority to pay current and ongoing payroll will need slight changes. One of the grounds commonly asserted for authority to pay petition date wages (which technically constitute unsecured pre-petition debts) is the no-harm-no-foul likelihood that claims for those wages would be afforded priority treatment under former §507(a)(3) up to the former $4,925/employee statutory cap (or less, depending on when the case was filed). Under new §507(a)(4), this cap has been increased to $10,000 and the 90-day look-back period has been expanded to 180 days. Thus, in cases with large first-day payroll issues, such as those with significant accrued sales commissions or executive salary arrearages, this revision should give first-day wage motions added muscle.

Conclusion

Preparing a chapter 11 case is already an arduous and fast-paced undertaking that can test the mettle of even the most fluent of multitaskers. In the aggregate, the new Code will make first-day planning even more challenging for debtor and counsel alike, especially if time-sensitive or big-dollar KERP, utilities or consumer data issues present themselves. As painful as it may be, however, practitioners entrenched in first-day forms of the past should heed the measurable breadth of the changes to the Code and start familiarizing themselves with the new provisions discussed above sooner rather than later.

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Footnotes

¹ 11 U.S.C. §366(b). Return to article

² In re Caldor Inc.-NY, 199 B.R. 1, 3 (S.D.N.Y. 1996), aff'd., Virginia Elec. & Power Co. v. Caldor Inc.-N.Y., 117 F.3d 646 (2d Cir. 1997); In re George C. Frye Co., 7 B.R. 856, 858 (Bankr. D. Me. 1980) (adequate assurance of payment does not mean guarantee of payment, but that a utility is not subject to an unreasonable risk of future loss). Return to article

³ 11 U.S.C. §503(c)(1)(A). Return to article

⁴ 11 U.S.C. §503(c)(1)(B). Return to article

⁵ 11 U.S.C. §503(c)(1)(C)(i). Return to article

⁶ 11 U.S.C. §503(c)(1)(C)(ii). Return to article

⁷ 11 U.S.C. §503(c)(2)(A). Return to article

⁸ 11 U.S.C. §503(c)(2)(B). Return to article

⁹ See, e.g., Dai-Ichi Kangyo Bank v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 242 B.R. 147, 155 (D. Del. 1999); In re Color Tile Inc., 171 B.R. 674 (Bankr. D. Ariz. 1994); In re Interco Inc., 128 B.R. 229 (Bankr. E.D. Mo. 1991). Return to article

¹⁰ See article on p. 1 of this issue for detailed treatment of this topic. Return to article

¹¹ New Code §101(41A) defines "personally identifiable information" to include a broad range of consumer personal data, including names, addresses, Social Security numbers and credit card account numbers. Return to article

¹² 11 U.S.C. §363(b)(1). Return to article

¹³ 11 U.S.C. §363(b)(1)(A). Return to article

¹⁴ 11 U.S.C. §363(b)(1)(B). Return to article

¹⁵ The maximum extensions under revised §1121(d) of the 120- and 180-day exclusive plan filing and solicitation periods are 18 and 20 months after the order for relief, respectively. Return to article

¹⁶ Under revised §365(d)(4), leases of nonresidential real property are deemed rejected on the earlier of (1) 120 days after entry of the order for relief or (2) entry of an order confirming a plan. Under §365(d)(4)(B), the 120-day period can be extended a maximum of 90 days, absent the lessor's consent. Compare this to former §365(d)(4), which allowed practically unlimited extensions of the former 60-day mandatory rejection period for "cause." Return to article