What You Don’t Know about the Bankruptcy Law

It's not just about individuals. Largely overlooked corporate provisions of the new law require companies to make quicker decisions on leases, pony up more upfront cash, and shed some of their exclusive right to file reorganization plans.

Over the past few months, the media has doggedly reported on the progress and final passage of the new federal bankruptcy law, focusing on its effects on individuals. The impact that it will have on business has gotten little attention.

Yet the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, adopted on April 20, will make seeking Chapter 11 protection a more onerous process, according to legal and turnaround management experts.

In some cases, it will force struggling companies to liquidate assets rather than focus on restructuring, says bankruptcy attorney Jon Schneider of Goodwin Procter LLP. That’s because provisions in the new law, which amends parts of the U.S. Bankruptcy Code, have the effect of requiring bankrupt companies to generate more upfront cash to pay administrative claims.

Other provisions narrow the timeframe for making decisions about whether to assume or break existing real estate leases, points out William Lenhart, a turnaround expert with BDO Seidman’s Financial Recovery Services. That’s likely to hurt retailing and other industries that need flexibility in planning locations, he notes.

At the same time, the provisions of the act, most which go into effect in late October, cut a wide swath across many aspects of corporate bankruptcy law. The new law is bound to introduce complications for bankrupt companies in such diverse areas as administrative-claim status, retention pay, inventory, utility payments, and relations with investment bankers.

Here, from a corporate-finance perspective, are some of the practical implications of the changes.

Quicker decisions on leases. One of the more troublesome changes of the new law, an amendment to Section 365(d)(4) of the bankruptcy code, pertains to real estate leases and the amount of time a bankrupt company has to decide whether to retain or break them. Before the law’s enactment, companies that filed for Chapter 11 had 60 days (from the filing date) to make their decision. As a matter of practice, says Lenhart, bankruptcy judges routinely granted as many extensions to the 60-day period as necessary.

But companies must now make their lease decisions within 120 days, and are only permitted one 90-day extension, for a maximum of 210 days. The new cap is sure to cause problems for retailers, restaurant chains, or any kind of operation that relies on multiple locations for success, says Lenhart.

In the past, legitimate extensions served as a testing period for reorganization plans, he explains. The time was used to track and analyze sales data so that management could figure out which locations were profitable and which ones to shutter. For the analysis to be effective, however, businesses had to operate at least during one heavy selling season, such as the Christmas rush.

Speeding up the testing period could force management to make rash decisions, reckons Lenhart. As a result, companies may emerge from bankruptcy with ineffective plans and end up either liquidating assets, or — in what lawyers lightheartedly refer to as Chapter 22 — a second bankruptcy.

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