1. © 2010 Bankruptcy Basics for the Non-Bankruptcy Lawyer Presentation by: Manuel D. Leal, Victor A. Vilaplana, Yolanda C. Garcia, James P.S. Leshaw, Omar J. Alaniz

2. 2 Overview of Today's Program General Bankruptcy Principles The Players The Claims Process Bankruptcy Court Jurisdiction Adversary Proceedings vs Contested Matters Preferences Fraudulent Transfers The Confirmation Process

3. 3 General Bankruptcy Principles

4. 4 General Bankruptcy Principles: Chapter 7 vs Chapter 11 Chapter 7 Trustee appointed - supplants debtor's management and liquidates estate property; powers also include avoidance actions (e.g., preference, fraudulent transfer actions) Cessation of all business operations Expeditious liquidation of assets and prompt distribution of proceeds to creditors under court supervision No restructuring obligations Provides a formulaic payment distribution scheme Chapter 11 Debtor remains in possession of company and management (Debtor-in-Possession); has all rights, duties, and obligations of trustee Designed to preserve "going concern value" of business (though liquidation is possible) Orderly, court-supervised process that allows entity or individual to reorganize Reorganized company (if not liquidated) emerges after court confirms the Chapter 11 Plan (examples: Texaco, GM, Chrysler, United Airlines) Chapter 7 distribution scheme serves as a baseline; chapter 11 provides a forum for negotiation

5. 5 General Bankruptcy Principles: Automatic Stay A statutory injunction that is automatic at the instant of the bankruptcy filing The following are prohibited: Demand letters or emails to the debtor Phone calls to the debtor demanding payment Acceleration of debt or notices of default Dilution or squeeze out remedies affecting a debtor's interest in a joint venture, partnership or corporation Filing lawsuits against the debtor or continuing prosecution of lawsuits that were already filed - this includes private arbitration Posting property for foreclosure or conducting foreclosure sales Perfection of security interest in collateral by filing UCCs or by filing deeds of trust Taking possession of collateral Setting off any debt owing to the debtor against any claims against the debtor

6. 6 General Bankruptcy Principles: Automatic Stay The stay does not prevent actions against guarantors, non- debtors, and non-estate property The stay is inapplicable to causes of action by the bankrupt debtor The stay can be lifted on motion to the Court There are exceptions to the automatic stay For example, police powers of governmental entities and safe harbor provisions

7. 7 General Bankruptcy Principles: Anticipation of a Bankruptcy Filing Automatic Stay 20-day Administrative Priority Claim Reclamation Rights Other Non-bankruptcy Law Rights Critical Vendor Payments Postpetition Trade Term Agreements Executory Contracts Setoff Rights Asserting Prepetition and Postpetition Claims Selling Your Claims

8. 8 The Players

9. 9 The Players: Debtor-in-Possession Debtor's management and board stay in possession and operate and oversee the business This is what is colloquially referred to as the "Debtor" All references to "Trustee" in the Bankruptcy Code apply to the Debtor-in-Possession if a Chapter 11 Trustee is not appointed (discussed later)

10. 10 The Players: Statutory Committees Intended to provide a unified voice to similarly situated stakeholders (especially those that can't afford their own counsel) Unsecured creditors' committee is appointed by the U.S. Trustee and has a broad creditor profile Additional committees may be appointed (e.g., producer's committee, asbestos committee, equity committee) Members owe fiduciary duty to constituents and commonly assert that the Debtor's plan improperly favors one group over another or does not maximize value (although maximizing value not always required) Fees/expenses of committee professionals (including experts and lawyers) are paid by the Debtor

11. 11 The Players: U.S. Trustee vs Chapter 11 Trustee United States Trustee Often referred to as the "Police" in the bankruptcy case (though the court is not obligated to rule in the U.S. Trustee's favor Division of U.S. Department of Justice May be heard on any issue in chapter 11 case Chapter 11 Trustee Replaces debtor's management and board, runs debtor's business, manages chapter 11 case, and can hire its own professionals (including lawyers) Extreme remedy, which requires a showing of case (e.g., fraud, dishonesty, incompetence, or gross mismanagement either before or after commencement of case)

12. 12 The Players: Repeat Players There are Many Repeat Players Law firms Lawyers Banks/Secured Creditors Landlords Employees/Unions Distressed debt firms who oppose/support the plan Financial advisors Representatives of asbestos claimants Representatives of environmental claimants Representatives of tort/products liability claimants

13. 13 The Claims Process

14. 14 The Claims Process: General Principles In Chapter 11, the court will set a bar date, and all claims must be filed before the date In Chapter 11, check the Debtor's Schedules to determine if your claim is scheduled. If claim is scheduled, creditor need not file claim unless (i) creditor disagrees with the scheduled amount or (ii) the claim is listed as disputed, contingent, or unliquidated. Filing a claim does not guarantee a recovery, but not filing a claim typically ensures no recovery

15. 15 The Claims Process: Allowance and Payment A timely filed claim is "allowed" until there is an objection If an objection to a claim is filed, the claim is "allowed" only after resolution Basis for claim objection may be state law or bankruptcy law (see 11 U.S.C. § 502(b)). For large creditors, negotiations will often occur with the debtor, and a deal may be reached to resolve the claim before confirmation Unless the debtor is solvent, the claimant will not recover 100% of the allowed claim value but will, instead, recover a pro rata distribution once the assets available to pay creditors are determined In some instances, claimants may be out of the money entirely

16. 16 Bankruptcy Court Jurisdiction

17. 17 Bankruptcy Court Jurisdiction 28 USC § 1334 – statutory jurisdiction to hear cases arising in, arising under or related to cases under title 11 Statutory authorization to hear and determine core matters and to make proposed findings of fact and conclusions of law on non-core matters Supreme Court limited jurisdiction in Stern v. Marshall

18. 18 Adversary Proceedings vs Contested Matters

19. 19 Adversary Proceedings Related to but separate from the bankruptcy Assigned a different case number and separate docket is maintained Most of the federal rules of evidence and civil procedure apply (though they are not strictly followed) They are essentially their own trials stemming from the bankruptcy Most often heard by the bankruptcy judge unless the "reference" is withdrawn, in which case, the district court hears the adversary proceeding

20. 20 Adversary Proceedings Rule 7001 defines causes of action that must be brought in an Adversary Proceeding (1) recovery of money or property (2) determining the validity, priority, or extent of a lien (3) obtaining approval for the sale of both the interest of the estate and of a co-owner in property (4) objection to or revoke a discharge (5) revoking a confirmation order (6) determining the dischargeability of a debt (7) obtaining an injunction (8) subordinating any allowed claim or interest (9) obtaining a declaratory judgment relating to any of the foregoing, or (10) determining a removed claim or cause of action

21. 21 Contested Matters Occur within the main bankruptcy case More akin to motion practice and are often resolved on dispositive motions without a trial However, contested matters can become complicated and hotly contested Hearing setting default is approx. 20-25 days after filing of motion but court has flexibility to expedite setting or set the hearing for a date certain If discovery is needed, parties can agree on a schedule and court approves Some Federal Rules of Civil Procedure apply (see Rule 9014)

22. 22 Contested Matters Examples of Contested Matters Motions to Lift the Automatic Stay Claim Objections Motions to Assume, Reject, or Assign Unexpired Leases or Executory Contracts Motions to Sell Property of the Estate Confirmation of a Plan of Reorganization

23. 23 Preferences

24. 24 Preference - Two Typical Scenarios Debtor is experiencing financial hardship so he/she chooses to pay the car, cell phone, and electric bill, but not his/her student loans, credit cards, or a promissory note. Debtor has preferred the creditors whose collection action are most likely to interrupt the debtors lifestyle. Sophisticated creditor is aware of a companys deepening insolvency and intensifies collection effort, extracts a payment, or files a lawsuit. Creditor is attempting to obtain as much of the shrinking pie before other creditors do. Sophisticated creditors have an advantage.

25. 25 Preference - General Preference law is entirely a creature of bankruptcy law. Preference (and fraudulent transfer) law enables the trustee or DIP to pull back property into the bankruptcy estate and redistribute that property to creditors according to the Bankruptcy Codes priority scheme (including to the parties whose transfers were avoided). Preference law is intended to prevent the race to the courthouse and to rebalance fair distribution among creditors who undertake disparate collection action.

26. 26 Preference - Hypothetical Prior to a bankruptcy filing, debtor has four creditors with the following unpaid claims: A - $100; B - $200; C - $500; D - $200. Assume total assets = $500. Debtor pays off D ($200) and 2 months later decides to file bankruptcy. Without preference law, remaining $300 is shared pro rata among unpaid creditors. Total claim pool is $800. Creditors receive 37.5% recovery: A - $37.50; B - $175; C - $187.50. D was paid $200 prior to filing. Utilizing preference law, trustee/DIP sues D for $200; bankruptcy estate increases to $500. Total claim pool is $1,000. Creditors receive 50% recovery: A - $50; B - $100; C - $250; D - $100.

27. 27 Preference - Elements A preference is only voidable if it meets all seven elements, and affirmative defenses often apply (discussed below). Seven elements of a voidable preference: a transfer of an interest in the debtors property on account of an antecedent debt made within the preference period (90 days before the bankruptcy filing for non-insiders; 1 year for insiders) while the debtor was insolvent to or for the benefit of the creditor that permits the creditor to receive more than it would under chapter 7 (liquidation) had the transfer not been made Notably absent: intent or state-of-mind

28. 28 Preference - Affirmative defenses Examples of Affirmative Defenses: Substantially contemporaneous exchanges for new value Ordinary course (can be ordinary course between parties or ordinary course in the industry) Purchase Money Security Interests Safe Harbor Provisions (protections for financial contracts such as derivatives, swap agreements, etc.)

29. 29 Fraudulent Transfer

30. 30 Fraudulent Transfer - General Fraudulent transfer law exists outside the bankruptcy context The Bankruptcy Code includes a fraudulent transfer statute, but the trustee or DIP may sue under a state fraudulent transfer law in addition to or instead of the bankruptcy law. Fraudulent transfer (like preference) law enables the trustee or DIP to pull back property into the bankruptcy estate and redistribute it to creditors according to the Bankruptcy Codes priority scheme (including to the parties whose transfers were avoided).

31. 31 Fraudulent Transfer Three types: Actual Fraud: 11 U.S.C. § 548(a)(1)(A) Constructive Fraud: 11 U.S.C. § 548(a)(1)(B) Partnership Transfers: 11 U.S.C. § 548(b) [not covered]

32. 32 Fraudulent Transfer - Actual Fraud Must prove an actual intent to delay, defraud, or hinder payment to creditors. Must show that the debtor had an intent to interfere with creditors' normal collection processes or with other affiliated creditor rights for personal or malign ends. No requirement of insolvency. Presumption of actual fraud in Ponzi schemes

33. 33 Fraudulent Transfer - Actual Fraud Badges of Fraud the lack or inadequacy of consideration the family, friendship, or close associate relationship between the parties the retention of possession, benefit or use of the property in question the financial condition of the party sought to be charged both before and after the transaction in question the existence or cumulative effect of the pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors the general chronology of events and transactions under injury

34. 34 Fraudulent Transfer - Constructive Fraud Must show that (i) the debtor received less than reasonably equivalent value of the asset and (ii) (a) the transfer was made while the company was insolvent, (b) the company was left with unreasonably small capital, or (c) the company believed that it would incur debts that would be beyond its ability to repay as the debts matured. No state-of-mind requirement Transfers for the benefit of insiders or obligations such as employment contracts during company's insolvency also satisfy the second prong

35. 35 The Plan Process

36. 36 The Plan Process Debtor formulates its "plan" to emerge from bankruptcy Stand alone plan Obtain exit financing Sell some or substantially all assets Merge/consolidate entities Debtor negotiates with key stakeholders to arrive at a consensual plan of reorganization Debtor drafts plan that will classify creditors and interest holders and sets forth distribution and payment terms Once debtor formulates plan (with or without agreement from key constituents), debtor will seek approval of a disclosure statement and distributes plan and disclosure for voting Creditors and interest holders may vote on the plan (unless they are not affected by the bankruptcy or they receive no property under the plan)

37. 37 The Plan Process: Confirmation Confirmation is the court's approval of the plan of reorganization or liquidation To confirm a plan, one must meet the statutory obligations under 1129 (15 tests for business cases) plan filed in good faith creditors receive at least as much as they would have in a chapter 7 unless the agree otherwise confirmation is not likely to be following by another bankruptcy or further restructuring voting thresholds are met Often, the court will consider only the Debtor's plan But if the Debtor's exclusivity is terminated, the court may consider multiple plans but can only confirm one Many aspects of litigation may come before confirmation (and may continue after)