The Bankruptcy Abuse Prevention And Consumer Protection Act Of 2005

On April 20, 2005, President George W. Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "2005 Act" or "BAPCPA"). While media and legislative attention has focused principally on the consumer bankruptcy aspects of the 2005 Act, BAPCPA also clarifies, expands, and adds a number of provisions to title 11 of the United States Code (the "Bankruptcy Code" or "Code") that will significantly impact business bankruptcies. This Alert describes briefly some provisions of the 2005 Act most pertinent to business cases. The vast majority of the changes effected by BAPCPA apply only to bankruptcy cases filed on or after October 17, 2005, i.e., 180 days after enactment. Some important changes, however, went into effect immediately upon enactment of the new law and one will be delayed until April 20, 2006.We have indicated the effective date for each amendment discussed below.

Bankruptcy Code § 547 permits the avoidance of preferential transfers made to or for the benefit of creditors during the 90 days immediately preceding the bankruptcy filing, subject to certain limitations and defenses; under Bankruptcy Code § 550, such avoided transfers may be recovered for the bankruptcy estate. For insiders of the debtor, the Bankruptcy Code expands the reachback period to one year prior to the bankruptcy filing. In 1989, the Seventh Circuit Court of Appeals in Levit v. Ingersoll Rand Financial Corp. (In re DePrizio), 874 F.2d 1186 (7th Cir. 1989), held that transfers made during the extended one-year insider preference period to non-insider lenders on account of a loan guaranteed by insiders were avoidable preferences that could be recovered from the non-insider lenders. The Seventh Circuit reasoned that such payments could be avoided and recovered because they benefited the insider-guarantors by reducing their contingent liability on the underlying obligation.

Congress attempted to overrule DePrizio in the Bankruptcy Reform Act of 1994 (the "1994 Act") by amending the Code to provide that transfers made to noninsider creditors during the insider preference period were not recoverable. However, some courts interpreted the amendment made by the 1994 Act to apply only to payments made to non-insider creditors and not to other transfers, such as liens granted on property of the debtor, during the extended insider preference period.

In order to eliminate this loophole, the 2005 Act amends the Bankruptcy Code's preference provision so that any preferential transfer made to a non-insider creditor during the 90-day-to-one year period preceding the petition date may not be avoided. [Effective Date: April 20, 2005 and applicable to all cases pending or commenced on or after that date]

Prior to the 2005 Act, a defendant attempting to establish the ordinary course of business defense in a preference action was required to prove that the transfer satisfied three tests, i.e., that the transfer was (1) in payment of a debt incurred in the ordinary course of business between the debtor and transferee, (2) made in the ordinary course of business between the debtor and transferee, and (3) made according to ordinary business terms. To satisfy the third test, many courts required the defendant to establish that the transfer was made in accordance with standard terms within the industry.

The 2005 Act makes the second and third tests described above alternatives. Thus, if the debt was incurred in the ordinary course, then the defendant will prevail if the transfer in question was either in the ordinary course of business between the debtor and the transferee or made according to ordinary business terms. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

A defendant may successfully defend against a preference action if it can establish that the challenged transfer was a contemporaneous exchange for new value given to the debtor. Under the Bankruptcy Code prior to the 2005 Act, perfection of a security interest within 10 days after it was granted was deemed "contemporaneous" with the grant. The 2005 Act extends this grace period from 10 days to 30 days. In addition, under the 2005 Act, a purchase money security interest perfected on or before 30 days (rather than 20 days) after the debtor received possession of the property will be deemed a "contemporaneous exchange." [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under the 2005 Act, it is a defense to a preference action brought in a business bankruptcy case if the aggregate value of the property that constitutes or is affected by the transfer is less than $5,000. In addition, an action by an estate representative to recover a non-consumer debt of less than $10,000 from a non-insider must be commenced in the district in which the defendant resides. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under Bankruptcy Code § 549, a bankruptcy trustee may avoid certain post-petition transfers of estate property. One exception to this general rule protects a post-petition transfer of real property for present fair equivalent value to a good faith purchaser without knowledge of the filing, when notice of the bankruptcy case has not been properly recorded. Some courts limited this exception to actual transfers of real property, thus excluding from protection the creation of a lien on real property. The 2005 Act amends both section 549(c) and the definition of "transfer" in Code § 101(54) to extend the exception to a "transfer of an interest in real property," such as creation of a lien. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

FRAUDULENT TRANSFERS 1

Under Bankruptcy Code § 548 prior to the 2005 Act, a fraudulent transfer or obligation made or incurred within one year before the petition date could be avoided without resort to state law. The 2005 Act extends the reachback period to two years. [Effective Date:April 20, 2006 and applicable to cases filed on or after that date]

Under the 2005 Act, a seller of goods will have an administrative expense claim for the value of any goods sold to the debtor in the ordinary course of the debtor's business and received by the debtor within 20 days prior to the petition date. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act also makes significant changes with respect to reclamation rights of those who sell goods to insolvent debtors prior to their bankruptcy filing. First, the applicable demand deadlines have changed. Under Bankruptcy Code § 546(c) prior to the 2005 Act, a seller could exercise its reclamation rights if it made written demand within 10 days after the debtor's receipt of the goods or, if the 10-day period straddled the petition date, the seller made demand within 20 days after the debtor's receipt of the goods. By contrast, BAPCPA allows the reclaiming seller to make written demand within 45 days after the debtor's receipt of the goods or, if the 45-day time period expires after the commencement of the case, the seller will have at least 20 days after the petition date to make its demand.

Second, the 2005 Act makes a seller's right to reclaim expressly subject to the prior rights of a holder of a security interest in the goods or their proceeds. Third, BAPCPA eliminates the provision of section 546(c) that permitted the court to provide a reclaiming seller an administrative expense claim in lieu of its right to reclaim. Thus, it appears that the debtor will actually have to return the reclaimed goods if they are still available. If the goods are unavailable for return to the reclaiming seller, it is unclear when the reclaiming seller will have a general unsecured claim for the price of the goods or an administrative expense claim.

Fourth, a seller's right to reclaim is made expressly subject to Bankruptcy Code § 507(c). Section 507(c) deals with the priority of claims of governmental units arising from an erroneous tax refund or tax credit. This reference is probably intended to be to section 507(b), which deals with administrative expense claims for failed adequate protection. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act adds subsection (c) to Bankruptcy Code § 503, which deals with allowance of administrative expenses. New subsection 503(c) places significant limitations on retention and severance programs for insiders of the debtor. The new law provides that payments and obligations for the purpose of inducing an insider to remain with the debtor's business may not be made unless (1) "essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation" and (2) "the services provided by the person are essential to the survival of the business." In addition, if those requirements are satisfied, the transfer or obligation cannot be greater than "10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or the obligation is incurred" or, if there were no such transfers or obligations, the post-petition transfer or obligation cannot exceed 25% of the amount of any similar transfer or obligation for the benefit of the insider during the previous calendar year. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Similarly, under new section 503(c), a severance payment cannot be made to an insider of the debtor unless "the payment is part of a program that is generally applicable to all full-time employees" of the debtor and "the amount of the payment is not greater than 10 times the amount of the mean severance payment given to nonmanagement employees during the calendar year in which the payment is made." [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

New section 503(c) also prohibits allowance or payment of "other transfers or obligations that are outside the ordinary course of business and not justified by the facts and circumstances of the case, including transfers made to, or obligations incurred for the benefit of, officers, managers or consultants after the date of the filing of the petition." This amendment appears to apply to all post-petition transfers or obligations, not just those to officers, managers or consultants. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

In addition to extending the fraudulent transfer reachback period to two years, as described above, the 2005 Act also permits the avoidance, as a fraudulent transfer under Bankruptcy Code § 548(a), of a prepetition transfer or obligation to or for the benefit of an insider of the debtor "under an employment contact and not in the ordinary course of business" if the debtor received less than reasonably equivalent value. To recover such a transfer, the estate representative does not have to allege or prove either actual fraudulent intent or any of the financial criteria for a constructive fraudulent transfer (such as insolvency or unreasonably small capital). [Effective Date: April 20, 2005 and applicable to cases filed on or after that date]

Bankruptcy Code § 507(a) provides that employee wage and benefit claims are entitled to priority to the extent such claims are earned within a specified time period prior to the petition date or cessation of the debtor's business and subject to a monetary cap. The 2005 Act enlarges both the statutory lookback period and the monetary cap on priority wage and benefit claims. The lookback period for wage claims is increased from 90 days to 180 days (matching the lookback period for benefit claims). In addition, the combined monetary cap on priority wage and benefit claims is increased from $4,925 to $10,000, subject to annual increases. [Effective Date:April 20, 2005 and applicable to all cases filed on or after that date]

In an amendment to Bankruptcy Code § 1104, the 2005 Act requires the United States Trustee to move for the appointment of a bankruptcy trustee if there are "reasonable grounds to suspect" that current members of the debtor's governing body, the debtor's CEO or CFO, or members of the governing body that selected the CEO or CFO "participated in actual fraud, dishonesty or criminal conduct in the management of the debtor or the debtor's public financial reporting." The 2005 Act does not, however, amend the grounds for the court to order the appointment of a trustee. [Effective Date:April 20, 2005 and applicable to all cases filed on or after that date]

The 2005 Act adds a new chapter 15 to the Bankruptcy Code, which enacts the Model Law on Cross-Border Insolvencies developed by the United Nations Commission on International Trade Law (UNCITRAL). Chapter 15 is intended to provide an effective mechanism for dealing with cross-border insolvency cases. In brief, chapter 15 replaces Bankruptcy Code § 304 and, subject to some exceptions, will apply when (1) assistance is sought in the United States by a foreign court or foreign representative in connection with a foreign proceeding, (2) assistance is sought in a foreign country in connection with a case under the Bankruptcy Code, (3) a foreign proceeding and a case under the Bankruptcy Code with respect to the same debtor are pending concurrently, or (4) creditors or other interested parties in a foreign country wish to commence or participate in a case or proceeding under the Bankruptcy Code. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

A debtor in chapter 11 enjoys an exclusive period during the initial stages of its case to file a plan of reorganization and to solicit acceptances of the plan. This period, which lasts for the first 120 days with respect to plan filing and 180 days with respect to vote solicitation, can be extended by the court for cause shown. Typically, debtors request repeated extensions of the exclusive periods. Under the 2005 Act, however, a debtor's exclusive period to file a plan will be capped at 18 months after entry of the order for relief (which is the petition date in a voluntary case) and its exclusive period to solicit votes on the plan will be capped at 20 months after the entry of the order for relief; no further extensions are permitted.[Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under the 2005 Act, confirmation of a chapter 11 plan will not discharge a corporate debtor from any debt arising for a tax or customs duty with respect to which the debtor made a fraudulent return or which the debtor "willfully attempted in any manner to evade or to defeat." In addition, confirmation of a plan will not discharge a corporate debtor from any debt that is owed to a domestic governmental unit and is the kind that would be excepted from discharge under Bankruptcy Code § 523(a)(2)(A) or (B). In general, section 523(a)(2)(A) and (B) except from discharge debts of individuals for certain types of fraud. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

BAPCPA also provides that confirmation of a plan does not discharge a corporate debtor from debt that is "owed to a person as a result of an action filed under subchapter III of chapter 37 of title 31 or any similar State statute." It is not clear whether this exception applies only to debts of the kind specified in section 532(a)(2)(A) and (B). However, since chapter 37 of title 31 deals only with claims asserted against the United States, it does not appear that a debtor other than the United States or a state could be subject to such nondischargeable claims. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act amends the Bankruptcy Code to make it clear that a debtor may continue soliciting acceptances of its "prepackaged" plan after the petition has been filed, notwithstanding the absence of a court-approved disclosure statement, if the solicitation complies with applicable nonbankruptcy law and if the holder was solicited before the commencement of the case in a manner complying with applicable nonbankruptcy law. In addition, if the debtor solicited votes on its plan prior to the commencement of the case, the 2005 Act permits the bankruptcy court, for cause, to order the United States trustee not to convene a meeting of creditors or equity security holders. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under the 2005 Act, official committees are required to provide "access to information" for and to "solicit and receive comments" from creditors whose interests are represented by the committee but who are not members of the committee. Committees may also be compelled by court order to provide additional reports or disclosures to such creditors. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act resolves a conflict in the case law as to whether a committee member is entitled to an administrative expense claim for attorneys' fees incurred by the member (as opposed to the committee itself) in connection with committee activities. Under the 2005 Act, Bankruptcy Code § 503(b)(4) is amended so that a committee member's separate counsel is not entitled to compensation as an administrative expense, absent qualification under some other provision of section 503(b). [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act provides that, on request of a party in interest, the bankruptcy court may order the United States trustee to change the composition of an official committee if such change is necessary to ensure adequate representation. In addition, the court may order the United States trustee to increase the number of committee members to include a creditor that is a "small business concern" if the court determines that the creditor's claim is "disproportionately large" when compared to the creditor's annual gross revenue. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act contains a number of significant tax-related provisions, some of which are:

Bankruptcy Code § 1129(a)(9)(C) specifies the required treatment of priority tax claims in a chapter 11 plan, absent a claimant's agreement to different treatment. Prior to the 2005 Act, such claims could be paid in deferred cash payments with a present value equal to the allowed amount of the claim over a period not exceeding six years after the date of assessment. BAPCPA amends this provision to require "regular installment payments in cash . . . over a period ending not later than 5 years after the date of the order for relief" (which may be significantly earlier than under prior law). Further, the claim must be paid "in a manner not less favorable than the most favored nonpriority unsecured claim provided for by the plan" other than claims in a convenience class. Resolving a split in the case law, the 2005 Act also provides that secured claims that would be priority tax claims if they were not secured are entitled to the same treatment in a plan as priority tax claims. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act adds a new section 511 to the Bankruptcy Code, which provides that, in the event a provision of the Code requires the payment of interest on a tax claim or an administrative expense tax or that a creditor receive the present value of the allowed amount of its claim (as Code § 1129(a)(9)(C) does), the rate of interest shall be the "rate determined under applicable nonbankruptcy law." It is unclear whether this rate of interest will be the default rate. For taxes to be paid under a confirmed plan, this rate of interest is to be determined as of the calendar month in which the plan is confirmed. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under Bankruptcy Code § 507(a)(8) prior to the 2005 Act, an unsecured property tax claim was entitled to priority treatment if it was assessed prior to the petition date and last payable without penalty within the year prior to the petition date. The 2005 Act changes the key date to when the tax was incurred so that a tax incurred prior to the petition date but assessed thereafter may be entitled to priority treatment. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

An amendment to Bankruptcy Code § 362 made by the 2005 Act permits the government to set off an income tax refund with respect to a taxable year that ended prior to the order for relief against an income tax liability for the same period. Further, if the setoff is prohibited by applicable nonbankruptcy law because of a pending action to determine the amount or legality of the tax liability, the taxing authority may hold the refund pending resolution of the action or provision of adequate protection for its secured claim. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act adds provisions to the Bankruptcy Code designed to protect the privacy of "personally identifiable information" (such as name, contact information, social security number and account number) provided by individuals who were customers of the debtor. In general, Code § 363(b)(1), as amended by BAPCPA, requires that any sale or lease of property of the estate be either consistent with the debtor's prepetition privacy policy or approved by the court, after notice and a hearing, "giving due consideration to the facts, circumstances, and conditions of such sale or lease . . . and finding that no showing was made that such sale or lease would violate applicable nonbankruptcy law." If the proposed transaction would be inconsistent with the debtor's prepetition privacy policy, the bankruptcy court is required to order the United States trustee to appoint a "consumer privacy ombudsman," who will be compensated at the expense of the estate, to assist the court in considering the facts, circumstances and conditions of the proposed transaction. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under Bankruptcy Code § 1112(b) prior to the 2005 Act, a bankruptcy court was permitted to convert a chapter 11 case to one under chapter 7 or dismiss the case for cause. By contrast, section 1112(b), as amended by BAPCPA, provides that, on request of a party in interest (but not the U.S. trustee or bankruptcy administrator), if the movant establishes cause, and "absent unusual circumstances specifically enumerated by the court that establish that the requested conversion or dismissal is not in the best interests of creditors and the estate," the court must dismiss or convert the case -- or, under section 1104(a) as amended, may appoint a trustee or examiner if the court determines such relief would be in the best interests of the creditors and the estate. The 2005 Act also amends and expands the list of occurrences that constitute "cause," which include "failure to maintain appropriate insurance that poses a risk to the estate or to the public," "unauthorized use of cash collateral substantially harmful to 1 or more creditors," "failure to comply with an order of the court," and "failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief."

While amended section 1112(b) is ambiguous, it appears that, in addition to demonstrating "unusual circumstances . . . that establish that the requested [relief] is not in the best interests of the creditors and the estate," a party opposing conversion or dismissal is also required to show that (1) there is a reasonable likelihood that a plan will be confirmed within the deadline set by the Bankruptcy Code for a small business case or, if not applicable, within a reasonable period of time, and (2) if the grounds for relief include an act or omission of the debtor, that there was a reasonable justification for it and that it will be cured within a reasonable period of time.

Absent consent by the movant or "compelling circumstances" that prevent the court from meeting the specified time limits, section 1112 as amended requires the court to commence the hearing on a motion to dismiss or convert not later than 30 days after the filing of the motion and to decide the motion not later than 15 days after the commencement of the hearing. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act implements significant changes to a utility's rights when its customer is subject to a bankruptcy petition. The basic concept that a utility may alter, refuse, or discontinue service to a customer in bankruptcy only if it does not receive timely adequate assurance of payment remains; however, its implementation has been changed dramatically in chapter 11. Under Bankruptcy Code § 366, as amended by BAPCPA, a utility may alter, refuse or discontinue service if it has not received assurance that it considers adequate within 20 or 30 days of the petition date.2 The court may modify the amount of assurance required, but in doing so, it cannot consider facts and circumstances that courts routinely considered prior to BAPCPA, namely, that the utility did not hold security prepetition, that the debtor paid for utility service on a timely basis prepetition, or that claims for postpetition utility service enjoy administrative expense priority. Further, amended section 366 specifically provides that administrative expense priority does not constitute assurance of payment; rather, "assurance of payment" is defined to mean security such as a cash deposit, a letter of credit or a surety bond. In addition, under the 2005 Act, utilities may recover or set off against a prepetition security deposit without notice or court order. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under Bankruptcy Code § 365(b)(1), a debtor may not assume an executory contract or unexpired lease unless, at the time of assumption, the debtor cures or provides adequate assurance that it will promptly cure any defaults. Section 365(b)(2) sets forth certain exceptions to this general rule and, prior to the 2005 Act, excused the debtor from curing a default that was a breach of a provision relating to "the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations." InWorthington v. General Motors Corp. (In re Claremont Acquisition Corp.), 113 F.3d 1029 (9th Cir. 1997), the Ninth Circuit interpreted this subsection to exclude breach of a "penalty rate or penalty provision," and concluded that nonmonetary defaults were not among the defaults excused from the cure requirement. Accordingly, the debtor in Claremont Acquisition was unable to assume and assign its franchise agreement because of its breach of the agreement's "going dark" provision.

The 2005 Act amends section 365(b) to codify the Ninth Circuit's holding in Claremont Acquisition as to executory contracts and personal property leases. With respect to real property leases, however, the 2005 Act generally overrules Claremont Acquisition by excusing from the cure requirement of section 365(b)(1)(A) "a default arising from failure to perform nonmonetary obligations under an unexpired lease of real property, if it is impossible for the trustee to cure such default by performing nonmonetary acts at and after the time of assumption." However, amended section 365(b)(1)(A) also provides that, with respect to nonresidential real property leases, a nonmonetary default that "arises from a failure to operate in accordance with" such lease must be cured by performance at and after the time of assumption and losses resulting from the default have to be compensated. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

BAPCPA also amends Bankruptcy Code § 1124, which defines the concept of "unimpairment," to conform with the amendments made to section 365(b). However, amended section 1129(2)(D) may be read more generally to provide that, if the holder of a claim or interest that is not based on an executory contact or lease (such as a loan) is compensated for any actual pecuniary loss arising from a failure to perform a nonmonetary obligation (other than a failure to operate under a nonresidential real property lease), that claim or interest is unimpaired. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Under Bankruptcy Code § 365(d)(4) prior to the 2005 Act, a lease of nonresidential real property under which the debtor was lessee was deemed rejected if it was not assumed or rejected within 60 days after the order for relief, unless the deadline was extended by the court for cause. There was no limit to the number of such extensions that could be granted. The 2005 Act amends section 365(d)(4) by: (1) extending the initial assumption/rejection deadline from 60 to 120 days; (2) permitting only an initial 90-day extension for cause without the prior written consent of the lessor; and (3) specifically providing that the lease must be assumed or rejected by the entry of the order confirming a plan. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

To ameliorate the effects of premature assumption that may result from these changes to the assumption/rejection deadline, the 2005 Act also amends Bankruptcy Code § 503(b) to limit the administrative expense claim arising from subsequent rejection of a nonresidential real property lease that has been assumed. That claim is limited to "a sum equal to all monetary obligations due, excluding those arising from or relating to a failure to operate or a penalty provision, for the period of 2 years following the later of the rejection date or the date of actual turnover of the premises, without reduction or setoff for any reason whatsoever except for sums actually received or to be received from an entity other than the debtor." The remainder of the lessor's claim will treated as a prepetition claim. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Prior to the 2005 Act, "single asset real estate" cases were limited to otherwise qualified debtors with "aggregate noncontingent, liquidated secured debts" not exceeding $4,000,000. The 2005 Act removes this monetary limit, thereby extending the Bankruptcy Code provisions affecting "single asset real estate" to a significantly larger population of debtors, i.e., all cases in which "real property constituting a single property or project, other than residential real property with fewer than 4 residential units, . . . generates substantially all of the gross income of [the] debtor and on which no substantial business is being conducted by the debtor other than the business of operating the real property and activities incidental thereto."

Most importantly, under Bankruptcy Code § 362(d)(3) (as amended by BAPCPA), unless the debtor has filed a plan that has a reasonable possibility of being confirmed within a reasonable time, a "single asset real estate" debtor is required, as a condition to continued protection of the automatic stay, to make monthly payments to creditors secured by such single asset real estate in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor's interest in the real estate. Under section 362(d)(3) as amended, such payments must commence by the later of (1) 90 days after entry of the order for relief or such later date as the court may determine for cause with such 90- day period or (2) 30 days after the court determines that the case involves "single asset real estate." The 2005 Act resolves a split in the case law by specifying that these payments may be made from rents or other income generated by the property. Whether such payments will ultimately be credited to interest or principal, should still depend on whether the secured party is oversecured. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Bankruptcy Code § 1114 requires a debtor desiring to modify a retiree health-related benefit plan after the petition date to negotiate with an authorized representative of the retirees and, if agreement cannot be reached, to demonstrate to the court that the modification is necessary to permit the reorganization of the debtor, treats all affected parties fairly and equitably and is "clearly favored by the balance of the equities." The 2005 Act adds to section 1114 a provision dealing with prepetition modification of retiree health-related benefit plans. It applies if an insolvent debtor modified such a plan during the 180-day period prior to the petition date. New section 1114(l) provides that, on motion of a party in interest, the court shall reinstate the benefits as of the date of the modification unless "the balance of the equities clearly favors such modification." In part because of a split in the case law regarding post-petition modification of retiree benefits under section 1114, it is unclear whether new section 1114(l) applies to modifications permitted by the terms of the affected benefit plan. [Effective Date:April 20, 2005 and applicable to all cases filed on or after that date]

The 2005 Act amends Bankruptcy Code § 342 to provide additional notice requirements with which a debtor must comply in order for notice to be effective. Most of the changes affect consumer cases, but some affect business cases as well. For example, if a debtor is required to give notice to a creditor, that notice must contain the name, address and last four digits of the debtor's taxpayer identification number. If the notice concerns an amendment that adds a creditor to the schedules of assets and liabilities, the debtor's full taxpayer identification number must be included in the notice sent to that creditor. Also, if during the 90 days preceding the commencement of a voluntary case, a creditor supplies the debtor in at least two communications with the debtor's account number and the address at which such creditor wishes to receive correspondence, then the debtor must send any notice required by the Bankruptcy Code to such address and include the account number in the notice.

Notice that does not conform to the requirements of amended section 342 is not effective until it is "brought to the attention of such creditor." If a creditor has established internal procedures for dealing with bankruptcy-related notices, then notice will not be "brought to the attention of such creditor" until it is actually received by the person or subdivision designated in those procedures to receive such notices.[Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

Bankruptcy Code § 327(a) sets forth requirements for the retention of estate professionals and section 328(c) sets forth grounds for denying compensation to professionals employed at the expense of the estate. In general, to be employed or paid the professional must be "disinterested." Under the Bankruptcy Code prior to the 2005 Act, the definition of "disinterested" specifically excluded (1) investment bankers for any outstanding securities of the debtor, (2) investment bankers for any security of the debtor issued within three years before the petition date and their attorneys, and (3) a director, officer or employee of any such investment banker within two years of the petition date.

BAPCPA amends the definition of "disinterested" by removing all of the references to investment bankers. However, if disinterestedness is required, investment bankers and their directors, officers, employees and attorneys will have to satisfy the remaining tests in Bankruptcy Code § 101 as amended. This includes the requirement that the person "not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason." [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

The 2005 Act includes amendments to the Bankruptcy Code and certain other statutes that are intended primarily to clarify and expand the scope of existing provisions protecting the enforceability of certain types of contractual remedies contained in specified categories of financial contracts, notwithstanding the insolvency of the counterparty. The overarching purpose of these amendments is to reduce "systemic risk" in the financial market, i.e., the risk that a failure of one counterparty to a financial transaction will in turn force defaults by one or more of its counterparties resulting in a cascading series of defaults that could threaten the stability of the financial system. The financial contract provisions protect against systemic risk primarily by ensuring that a financial market participant is able to enforce its contractual rights to promptly terminate financial contracts with a counterparty that becomes insolvent, to liquidate and net mutual obligations under the contracts, and to promptly foreclose on collateral securing the counterparty's obligations.

The means of achieving these assurances include specific exemptions from provisions of the Bankruptcy Code that could otherwise prevent or delay the enforcement of these contractual rights, including the automatic stay, provisions permitting avoidance of a transfer as a preference or fraudulent conveyance, and provisions permitting a trustee to reject unfavorable contracts while assuming the benefit of favorable ones with the same counterparty. This latter possibility, often referred to as "cherry picking," has long created anxiety in the financial markets; and much attention, including legislative action, has been given to protecting the enforceability of "netting contracts" that permit "close-out netting" of transactions with an insolvent counterparty. Close-out netting is particularly critical because of the frequency with which multiple and often substantially offsetting transactions exist between major participants in the financial markets. Common examples are multiple transactions between the same parties pursuant to an ISDA Master Agreement and the large number of individual transactions that may exist between a securities or futures clearing organization and each of its members.

The applicability of specific statutory protections generally turns on the characterization of (i) the parties to a financial contract or transaction (e.g., as "financial institutions" or "clearing organizations," etc.), (ii) the contract or transaction itself (e.g., as a "qualified financial contract," "securities contract," etc.) or (iii) a particular right or obligation (e.g., as a "settlement payment" or "margin payment"). The financial contract provisions of the 2005 Act primarily clarify provisions that already exist, or expand their scope, or add parallel provisions to include additional categories of parties, transactions or rights and obligations. Certain amendments conform provisions across different applicable statutes.

The 2005 Act broadens the class of protected parties by defining a class of "financial participants" based on the dollar volume of their participation in protected classes of transactions. These financial participants will be allowed to close out and net transactions with insolvent counterparties even though they do not otherwise qualify, for example, as "commodity brokers" or "forward contract merchants." "Financial participants" also include clearing organizations, and this and other changes are intended to further the goal of promoting the clearing of derivatives and other financial transactions as a means of reducing systemic risk.

The 2005 Act adds new definitions to the Bankruptcy Code of "master netting agreement" and "master netting agreement participant." These are intended to protect "cross-product" netting agreements that could encompass a wide variety of transactions cutting across existing categories such as "securities contract," "swap agreement," "commodity contract," etc. The definitions of these and other specific types of transactions have also been broadened both in the Bankruptcy Code and in other statutes. For example, under the 2005 Act, the definition of "securities contract" is amended to expressly include margin loans, and the definition of "swap agreement" is amended to ensure the inclusion of a wide variety of transactions and reference interests (e.g., weather) that are and will be encompassed by the still-expanding swap markets. Importantly, new Bankruptcy Code § 561 clarifies that the provisions of the Code relating to securities contracts, commodity contracts, repurchase agreements and other specific types of contracts apply in a proceeding ancillary to a foreign insolvency proceeding under new chapter 15 of the Code. [Effective Date: October 17, 2005 and applicable to cases filed on or after that date]

This article has been prepared by Sidley Austin Brown & Wood LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Readers should not act upon this without seeking professional counsel.