On April 20, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”) was enacted into law. The Act, which generally applies to bankruptcy cases commenced on or after October 17, 2005, makes a number of substantial changes in federal bankruptcy law. Although the most drastic changes in the Act relate to consumer bankruptcies, there are also important changes involving business bankruptcies. Now that the Code amendments are fully effective, and bankruptcy courts (and litigants) are working through the issues raised by these amendments in practice, we thought it germane to remind you of the primary changes effected by the amendments.

Some of the more significant business and consumer bankruptcy provisions of the Act are discussed below:

• Click here for Business Bankruptcy Provisions.
  
• Click here for Consumer Bankruptcy Provisions.
  

A Chapter 11 debtor’s exclusive period to file a reorganization plan (which may be extended indefinitely under current law for cause shown, and in many larger cases has been extended for years) will be limited under the Act to a period of 18 months from the date the debtor files a Chapter 11 petition. This time limitation is likely to impact the ability of large and complex debtors to achieve a consensual Chapter 11 plan within the prescribed time frame. This presumably will shift negotiating leverage from the debtor to creditor constituencies or may result in the debtor proposing a plan without the support of its major creditors.

Under current law, a debtor-tenant has 60 days after filing bankruptcy to assume or reject a non-residential real property lease. This time period may be extended for cause shown, and multiple extensions are frequently granted, particularly in cases involving large debtors or numerous leases. The Act requires the debtor to assume or reject non-residential real property leases within 120 days after the bankruptcy case commences (or the date of confirmation of a plan, if earlier). While the bankruptcy court may, for cause, extend the 120-day period for up to an additional 90 days, any further extensions require the lessor’s consent. This should provide lessors with more leverage in negotiations and make reorganization more difficult for retailers and other debtors with many leases.

The Act imposes significant restrictions on the payment of retention bonuses, severance pay and other amounts to executives of a debtor in bankruptcy, severely curtailing the broad discretion provided to bankruptcy courts under current law.

The Act prohibits a bankruptcy court from approving administrative expense treatment (with payment priority over other unsecured claims) for retention payments to insiders (which include directors, officers or persons in control of the debtor) unless the court finds that: (i) such payment is essential to the person’s retention based on a bona fide job offer from another business at the same or greater pay; (ii) the insider's services are essential to the survival of the business; and (iii) the amount of such payment does not exceed either 10 times the mean amount of similar transfers paid to nonmanagement employees during the same calendar year, or if there are no such transfers, 25% of the amount of any similar transfer to the insider during the preceding calendar year.

Likewise, the Act prohibits administrative expense treatment for severance payments to insiders unless the court finds that: (i) such payment is part of a program generally applicable to all full-time employees; and (ii) the payment amount is not greater than 10 times the mean severance paid to nonmanagement employees in the same year.

The Act also prohibits administrative expense treatment for other payments outside the ordinary course of business and not justified by the circumstances, including amounts paid to officers, managers or consultants hired after the bankruptcy filing.

Under the Act, sellers can reclaim goods sold in the ordinary course of the seller’s business to an insolvent debtor within 45-days before the filing of the bankruptcy case if a written demand is made to the debtor within 45 days after receipt of the goods, or within 20 days after the case commences, if the case is filed within 45 days after the debtor receives the goods. This is a substantially longer period than that provided under current law, which requires the seller to make a reclamation demand within 10 days after the debtor received the goods, or within 20 days after receipt of the goods if the bankruptcy case is filed within the 10-day period. The Act also provides administrative expense treatment for the value of goods received by a debtor in the ordinary course of business within 20 days before the bankruptcy case commences, regardless of whether the seller makes a written reclamation demand. By contrast, under current law, a seller loses its reclamation rights (and potential entitlement to administrative expense treatment) if it fails to make a timely written reclamation demand.

The Act significantly expands the remedies available to a non-debtor party under certain financial contracts (including swaps, forward contracts, repurchase agreements and securities contracts) in the event of the bankruptcy of the contract counterparty. The Act generally broadens the circumstances under which the non-debtor party may exercise its contractual rights to liquidate, terminate, accelerate or setoff amounts owing under the financial contract.

Current bankruptcy law allows a debtor or bankruptcy trustee to recover as a “preference” the transfer of an insolvent debtor’s interest in property to or for the benefit of a creditor, made within 90 days (or one year with respect to an insider) before the filing of the bankruptcy case, which allows the creditor to receive more than it would have in a Chapter 7 liquidation case if the transfer had not been made. The Act broadens the defenses to preference recovery in several respects. The change likely to have the most widespread impact is the expansion of the “ordinary course of business” defense. While the creditor still must establish that the subject debt was incurred in the ordinary course of business between the parties, it need only show that the challenged payment was either (i) made in the parties’ ordinary course of business, or (ii) made according to ordinary business terms, rather than establishing both of these factors, as required under current law.

Current bankruptcy law as interpreted by some courts permits a Chapter 7 debtor to retain a secured creditor’s collateral merely by continuing to make installment payments. The Act makes clear that Chapter 7 debtors may no longer retain a secured creditor's collateral without executing a reaffirmation agreement and continuing to make installment payments. The Act also imposes numerous additional conditions for the effectiveness of reaffirmation agreements, including requiring that the creditor provide extensive disclosures to the debtor, and requiring the debtor to disclose certain information prior to the filing of a reaffirmation agreement with the Bankruptcy Court.

The Act adds a number of provisions designed to curtail the number of serial (i.e., repeat) bankruptcy filings by debtors. The minimum time interval between a debtor’s receipt of a Chapter 7 discharge is expanded from six years under current law to eight years under the Act. A debtor also cannot receive a Chapter 13 discharge if the debtor received a discharge under Chapter 7 or 11 within four years prior to the filing of the Chapter 13 case. The Act also amends the Bankruptcy Code to provide that the automatic stay terminates 30 days after a bankruptcy petition is filed if a previous Chapter 7, 11 or 13 case was filed by the debtor and dismissed within the previous year (unless the subsequent case is determined by the court to have been filed in good faith).

To protect creditors who exercise their rights against a debtor without receiving effective notice of the debtor’s bankruptcy filing, the Act provides that no monetary penalty may be imposed on a creditor for violating the automatic stay or failing to turnover property to the bankruptcy estate, unless prior notice was provided to the creditor in a prescribed form.

The Act amends the “cramdown” provisions applicable to Chapter 13 cases to provide that a debtor may not “strip down” a purchase money security interest (i.e., eliminate the undersecured portion of a secured creditor's claim by making payments equal to the value of the collateral) if the collateral is a motor vehicle and the debt was incurred within two and one-half years of the date of the bankruptcy filing, or, if the collateral is other than personal property and the debt was incurred within one year before the Chapter 13 case was commenced. The Act also provides that a Chapter 13 plan may not provide for the release of a lien upon payment of a stripped-down secured claim. Rather, the secured creditor retains their lien until the full amount of the claim is paid or the Chapter 13 plan is completed.

The list of debts exempt from discharge in a Chapter 13 case is expanded under the Act to include claims for fraud (including credit card misuse), embezzlement, breach of fiduciary duty, criminal restitution and fines, civil restitution and damages awarded for willful or malicious injuries, and unscheduled debts.

The Act amends TILA to impose numerous additional disclosure requirements on lenders who make consumer loans. Some of the more important additional disclosure requirements include:

• (1) Minimum Payment Disclosures: Under the Act, lenders will now be required to make specific disclosures on the front of each periodic statement concerning the consequences of making only minimum payments on open-end credit accounts including: (a) a statement that making only the minimum payments will increase the interest costs and the time it will take to repay the account balance; (b) providing a standard example showing the length of time it will take for a borrower to repay its balance by making only the minimum payment on the account; and (c) providing a toll free number that consumers may call to receive additional repayment information.
  
• (2) Introductory Rates: Under the Act, applications or solicitations for credit cards will now be required to conspicuously disclose: (a) that a rate being offered to the customer is an introductory rate; (b) if the rate that will apply at the end of the introductory period is fixed, the fixed rate that will apply to the account at the end of the introductory period (and when the fixed rate will go into effect); (c) if the rate that will apply at the end of the introductory period is variable, the variable rate that will apply to the account at the end of the introductory period based on the rate in effect within 60 days of the mailing of the application (and when the variable rate will go into effect); and (d) the circumstances, if any, under which the introductory rate can be withdrawn (and the rate that will apply if the introductory rate is withdrawn).
  
• (3) Internet-Based Solicitations: The Act imposes new disclosure requirements respect to internet-based solicitations by lenders. Under the Act, lenders will now be required to clearly and conspicuously provide certain TILA solicitation disclosures with any internet-based credit card solicitations.
  
• (4) Late Payment Deadlines and Penalties: Under the Act, a lender will now be required to disclose the date a payment is due, and if different from the date listed on the billing statement, the earliest date that a late payment charge can be assessed.

Under the Act, lenders will now be precluded from terminating open-end credit accounts solely because the consumer has not incurred finance charges on such accounts. However, a lender is not precluded from not renewing such accounts.

This Alert is only a brief summary of some aspects of the Act and does not necessarily address its application in specific circumstances. Please contact Gary M. Kaplan (gmkaplan@howardrice.com or 415-765-4671) or your usual Howard Rice attorney to learn more about the Act and how it may pertain to your particular circumstances.

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Copyright © 2005 Howard Rice Nemerovski Canady Falk & Rabkin PC, Three Embarcadero Center, Seventh Floor, San Francisco, CA 94111. Permission is granted to make and redistribute, without charge, copies of this entire document provided that such copies are complete and unaltered and identify Howard Rice as the author. All other rights reserved.