Chapter 11 | Fraser Blog

Five Stories that Matter in Michigan This Week – June 10, 2022

Five Stories that Matter in Michigan This Week – June 10, 2022; Legal, Legislative, and Regulatory Insights

Wayne County Announces $54 Million Fund for Small Businesses

A new $54 million fund to support small businesses, called the Wayne County Small Business Hub, was announced at last week’s Detroit Regional Chamber’s Mackinac Policy Conference (“Mackinac Conference”). It will provide support to new and existing businesses, with a specific focus on minority- or women-owned businesses, and micro businesses with 10 or fewer employees with a focus on technical assistance.

Why it Matters: Small businesses are often the first to be hit when the economy slows, and with credit markets tightening there are likely to be fewer sources of liquidity for small business owners to tap. This new fund, a collaboration between the Wayne County Executive’s Office and New Economy Initiative, will provide needed resources for historically disadvantaged businesses.

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Ford and Pfizer to Make Significant Investments in Michigan

Also at the Mackinac Conference, Ford Motor Company and Pfizer announced significant investments in Michigan. Ford reportedly will spend $2 billion across the company’s Michigan plants, and intends to create more than 3,000 jobs. Pfizer will make a $120 million investment at its Kalamazoo facility.

Why it Matters: With a great deal of economic doom and gloom in the headlines, these announcements are bright spots showing that large companies are still making investments in their businesses—and in Michigan, in particular.

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Concerns Expressed About Losing Another EV Investment in Michigan

But it’s not all good news on the economic front in Michigan. At the Mackinac Conference, John Rakolta Jr., chairman of Walbridge, pointed out that Michigan is missing out on major opportunities in the electric vehicle industry. For example, Stellantis announced last week that it was bypassing Michigan and locating its new electric vehicle battery manufacturing plant in Kokomo, Indiana.

Why it Matters: According to a study by Fortune Business Insights, the global electric vehicle market is expected to grow from approximately $287 billion in 2021, to $1.3 trillion by 2028. To take advantage of this opportunity, Michigan must make itself attractive to companies in the electric vehicle market. As Rakolta points out, this involves more than designing tax incentives. It requires a more comprehensive approach to utilities, zoning and other important business, financial, legal and regulatory issues.

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Unemployment Claimants Get to Keep Pandemic Overpayments

Michigan sought to claw back Pandemic Unemployment Assistance benefits paid to many Michigan residents who were accused of misreporting their income. Michigan argued that claimants were liable because they entered their gross pay from prior years to determine their weekly benefit amount when they should have entered their net pay. Michigan reversed course and announced that it would no longer seek to claw back the funds after media reports revealed that at least some claimants were asked during the application process to provide total pay—not net pay—which resulted in confusion and overpayments.

Why it Matters: This announcement surely came as a relief to many Michigan residents who were embroiled in disputes with the Michigan Unemployment Insurance Agency. More broadly, this situation demonstrates the importance of using precise, accurate language in contracts and other important documents. The alternative is to invite confusion, dispute and litigation.

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Michigan Cannabis Company Files for Chapter 11 Bankruptcy

A Kalamazoo cannabis company, Master Equity Group, recently filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court in the Western District of Michigan.

Why it Matters: This case will be closely watched by the cannabis industry, as well as by corporate restructuring professionals. Bankruptcy courts have historically prevented cannabis companies from filing for protection under the United States Bankruptcy Code because, while marijuana is legal in Michigan, it remains illegal under the federal Controlled Substances Act. And because bankruptcy courts are federal courts, similar attempts by cannabis companies to file for bankruptcy protection have been disallowed.

Related Practice Groups and Professionals

Administrative & Regulatory | Michael Ashton
Business & Tax | Mark Kellogg
Labor, Employment & Civil Rights | Aaron Davis
Cannabis | Klint Kesto

Recent Amendments Place Creditors in a Stronger Position to Defend Against Chapter 11 Bankruptcy Preference Lawsuits

As the bankruptcy wave continues to build, more businesses are being forced to deal with bankrupt customers. What’s worse—and which often comes as a big surprise—is when a business gets sued by the debtor or bankruptcy trustee seeking to recover payments made by the debtor before the bankruptcy. Such lawsuits, which attempt to recover “preferential payments,” cost businesses time, require the expenditure of legal fees, and often result in the business paying a settlement amount to make the matter go away.

With more companies filing for bankruptcy, the likelihood that businesses will face preference lawsuits is growing. Fortunately, the Bankruptcy Code provides creditors with certain defenses they can use to ward off a preference lawsuit, and Congress recently took action that strengthens those defenses. The “Small Business Reorganization Act of 2019” (SBRA), which went into effect in February, 2020, contains amendments to Chapter 11 bankruptcy preference law that are not limited to small business reorganizations.

What is a Preference Lawsuit?

Section 547 of the Bankruptcy Code allows a debtor or bankruptcy trustee, subject to certain defenses, to recover payments made to creditors within 90 days of the filing of the petition. The look-back period for payments is increased to one year for “insiders.” The policy behind preference actions is that they prevent aggressive collection action against a debtor that might force a debtor into bankruptcy, and they also help ensure equal treatment of creditor claims.

For example, if one creditor receives payment on a debt in the days leading up to a bankruptcy filing due to aggressive collection action, but another similarly situated creditor doesn’t receive payment because it did not engage in collection action, then the latter would only be left with a claim in the bankruptcy. The preference provisions allow the pre-petition payments made to the aggressive creditor to be clawed back, allowing each creditor’s claim to receive equal treatment in the bankruptcy. That’s how the system is supposed to work.

In reality, all kinds of creditors, including those who have valid defenses to preference claims, typically get sued regardless of their defenses. Prior to the recent amendments, the Bankruptcy Code did not explicitly require debtors to conduct any due diligence as to defenses prior to filing a preference lawsuit. Historically, debtors simply sued all creditors who received payments within the 90-day period before the bankruptcy, and creditors were left to deal with such lawsuits, often filed in far-flung jurisdictions, on a one-off basis. The recent amendments to the Bankruptcy Code’s preference provisions address these issues.

Amendments to Preference Provisions

The SBRA created a new “subchapter V” to Chapter 11 of the Bankruptcy Code, which provides small business debtors an easier path through bankruptcy. Less discussed is the fact that the SBRA contained two amendments to preference laws that strengthen defenses against preference lawsuits in all Chapter 11 cases.

Prior to the amendments, debtors had to meet a low bar to file a preference lawsuit. It was relatively easy for debtors to meet their burden of proof, and once they did the burden shifted to creditors to establish defenses. The SBRA places an additional hurdle in front of debtors. Now, a debtor or trustee must consider a creditor’s statutory defenses before filing a lawsuit “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses….” Previously, the Bankruptcy Code stated that a debtor or trust “may” do so.

Accordingly, there is now an affirmative obligation that a debtor or trustee investigate whether a creditor has a “subsequent new value”, “ordinary course of business” or other defense before moving forward with a preference action. Failure to do so may result in the dismissal of a case and/or an assertion of bad faith filing. Of course, one of the questions that will be sorted out over time in the courts is what constitutes “reasonable due diligence.”

Another welcome change for creditors included in the SBRA relates to the venue in which preference cases may be brought. Prior to the recent changes, the Bankruptcy Code provided that preference claims under $13,650 were to be brought in the district where the defendant resides, rather than where the bankruptcy case was pending. The SBRA raises this threshold amount to $25,000. This change will have a big impact, because it lessens the likelihood of preference claims of less than $25,000 being filed at all, given the costs associated with bringing an action in a distant jurisdiction.

In sum, the SBRA is good news for preference defendants. In fact, many creditors who would have otherwise been sued prior to the amendments will never become a “defendant” in the first place, given the additional obstacles debtors and trustees must overcome.

This alert serves as a general summary, and does not constitute legal guidance. Please contact us with any specific questions.

We have created a response team to the rapidly changing COVID-19 situation and the law and guidance that follows, so we will continue to post any new developments. You can view our COVID-19 Response Page and additional resources by following the link here. In the meantime, if you have any questions, please contact your Fraser Trebilcock attorney.

Jonathan T. Walton, Jr.’s legal practice focuses on cases arising from commercial transactions, the Uniform Commercial Code, the federal and state securities laws, banking laws and bankruptcy litigation. In the areas of banking, commercial, construction and real estate litigation, he represents lenders, contractors and owners on construction-related claims, and lenders and borrowers in commercial and residential foreclosure matters, large loan defaults and collections, lien priority disputes, and title insurance company liability. He can be reached at (313) 965-9038 or jwalton@fraserlawfirm.com.

As Chapter 11 Bankruptcy Filings Surge, Here’s What Creditors Need to Know to Protect and Enforce Their Rights

The National Bureau of Economic Research recently announced that the U.S. economy officially entered a recession in February, 2020, one month before COVID-19 shut down much of the economy. It should come as no surprise, therefore, that the economic downturn has led to a surge in corporate bankruptcy filings. According to data from Epiq Global, 722 companies sought bankruptcy protection around the U.S. last month, a 48-percent increase from the year-ago period. From Hertz to J.C. Penny, more businesses are seeking refuge to restructure their debts.

As chapter 11 bankruptcies continue to increase (many analysts are forecasting the “wave” of filings to grow), more businesses and individuals will be impacted by the fallout. Creditors of a bankrupt company must be aware of the various deadlines and procedures that govern the chapter 11 process in order to protect and enforce their rights. For creditors to maximize their recoveries, they must stay informed and take action during a bankruptcy proceeding.

Whenever a business or individual receives a notice from a United States Bankruptcy Court indicating that a business they have had dealings with has filed a chapter 11 bankruptcy petition, the clock starts ticking, and they should be aware of the following timeline, and key events and milestones that may affect their rights.

The Petition Date

The petition date is the date on which a debtor files a chapter 11 bankruptcy proceeding. The debtor is required to serve all known creditors with notice of the commencement of the chapter 11 case. An “automatic stay” is imposed as of the petition date, which prevents creditors from taking any further action, such as pursuing collection activity, related to a pre-petition debt.

To remain informed throughout a bankruptcy proceeding, a creditor may request to receive notice of all pleadings filed in a case pursuant to Federal Rule of Bankruptcy Procedure 2002. In addition, creditors have an opportunity to obtain information about a case and the debtor’s finances by attending the “Section 341” meeting of creditors that takes place shortly after a case is filed.

“First Day” Motions

In most chapter 11 cases, the debtor files a series of “first day” motions with the bankruptcy court seeking relief that it may not otherwise be automatically entitled to receive under the Bankruptcy Code. Such relief may include a request to pay some unsecured creditors (such as employees or “critical vendors”) ahead of others. Because debtors require sufficient cash to operate their businesses and pay for the administrative expenses of the chapter 11 process, many seek interim court approval for financing (called “debor-in-possession” or “DIP” financing) and/or the use cash collateral that is subject to a secured creditor’s lien. In some cases, the debtor’s pre-petition lender becomes the DIP lender, and in other cases a new lender, or syndicate of lenders, steps in and tries to “prime,” or supersede, an existing lender’s lien to the extent of DIP financing extended to the debtor.

It is important for creditors and their advisors to carefully review “first day” motions in order to know how their rights may be affected, and take action as appropriate. For example, while the Bankruptcy Code allows for a DIP loan to prime the lien of an existing secured creditor, the secured creditor must receive “adequate protection” that its position will not be diminished as a result of the use of cash collateral or new financing. A creditor may need to file an objection to requested first-day relief to protect its rights.

Proof-of-Claim Bar Date

In order to participate in the distribution of the debtor’s assets to satisfy pre-petition claims, a creditor must have a valid claim. After filing for bankruptcy, a debtor is required to file a schedule of assets and liabilities, which is supposed to include all claims against the debtor. If a creditor agrees with the debtor as to the amount listed for its claim in the debtor’s schedules, and the claim is not listed as contingent, unliquidated or disputed, then the creditor does not need to file a proof of claim. However, if a creditor disagrees with how its claim is scheduled, then it must file a proof of claim in order to preserve its rights.

The bankruptcy court will enter a bar date setting a deadline by which claims must be filed, and the debtor will mail notice of the bar date, as well as other details of the claims filing process, to creditors. To the extent a creditor fails to file its claim by the bar date, it may be objected to and disallowed as untimely. Your attorney can help you through the process of understanding the deadlines associated with filing your claim, as well as supporting your claim with sufficient evidence to prove what you are owed.

Debtor’s Post-Petition Obligations

In chapter 11, a business keeps running with the goal of reorganizing, which means that expenses continue to accrue after it files for bankruptcy. A debtor is required to pay all post-petition expenses in the normal course of business. Unlike pre-petition debts, post-petition debts are not subject to the automatic stay—the debtor is required to pay such debts and creditors can and should take action with the bankruptcy court to ensure they get paid.

Post-petition debts are given priority as “administrative claims,” which are actual, necessary costs and expenses of preserving the estate. Accordingly, a creditor that is, for example, supplying goods (post-bankruptcy) to a debtor under a supply agreement is entitled to be paid for those goods as an administrative claim, and can petition the bankruptcy court to order payment to the extent it is being wrongfully withheld. Those who deliver goods to the debtor within 20 days of the petition date are also entitled to an administrative expense claim. While neither the Bankruptcy Code nor Bankruptcy Rules establish a specific date by which a party must file a motion for allowance of an administrative expense claim, such deadlines are typically set by local rule and/or in a scheduling order entered by the bankruptcy court.

Conversely, a creditor must also perform its post-petition obligations to a debtor. A creditor who refuses to perform its obligations under a valid contract due to a debtor’s failure to pay for goods or services pre-petition can be compelled to perform post-petition.

Executory Contracts

Debtors are authorized to assume or reject executory contracts in chapter 11. An executory contract, while not defined under the Bankruptcy Code, generally is one in which both parties have performance obligations remaining under the contract. Unlike in chapter 7 bankruptcy, there is no specific deadline for chapter 11 debtor to assume or reject an executory contract. If a debtor decides to reject a contract, the contract is treated as breached and a creditor has an unsecured claim for damages. If a contract is assumed, meaning the debtor wants to keep the contract in place, any defaults under the contract, including pre-petition defaults, must be cured. A debtor must obtain bankruptcy court approval to assume or reject an executory contract, either by motion or through the plan confirmation process.

Unexpired Leases

While non-residential real property leases are executory contracts, they are treated a bit differently than other contracts. A debtor must take action to assume or reject a lease within 120 days of the petition, with an option to seek one 90-day extension for cause. In addition, to the extent a lease is rejected, damages, which constitute an unsecured claim, are capped at the greater of (1) one year’s rent or (2) the rent for 15 percent, not to exceed three years, of the remaining term of the lease.

Plan Confirmation Issues

Most unsecured creditors won’t have their pre-petition claims paid until after a debtor’s plan of reorganization is submitted to and approved by the bankruptcy court. A debtor has a 120-day period during which it has an exclusive right to file a plan. The exclusivity period may be extended or reduced by the court, but in no case can the exclusivity period be longer than 18 months. After the exclusivity period has expired, a creditor may file a competing plan.

A plan must be proposed alongside a disclosure statement, which is meant to flesh out all of the important details that interested parties should know to make an informed decision regarding the plan. Unsecured creditors whose rights are “impaired” are entitled to vote on a plan, as well as object to it. Deadlines for (i) requesting the debtor include certain information in a disclosure statement, (ii) filing a combined plan of reorganization and disclosure statement, (iii) returning voting ballots on the plan, (iv) filing objections to the approval of the disclosure statement, and (v) objections to confirmation of the plan of reorganization are set by the bankruptcy court in accordance with the Bankruptcy Code, Bankruptcy Rules, and local rules.

Know Your Obligations, Rights, and Remedies

Chapter 11 bankruptcy is a complex process. Unfortunately, due to the economic downturn, more creditors are going to be mired in the complexity of monitoring cases moving forward. In most cases, especially those when significant sums of money are at stake, it’s important to consult with legal counsel in order to understand your obligations, rights, and remedies with respect to a chapter 11 debtor. Keep in mind that there are steps creditors can take to protect themselves in advance in the event of a customer’s bankruptcy.

If you have questions about the process, or require the assistance of legal counsel to help protect your rights, please contact an attorney at Fraser Trebilcock.

Fraser Trebilcock Attorney Amanda S. Wolanin specializes her practice in business and tax law, bankruptcy, family law, estate planning, litigation, and real estate law. You can reach her at (517) 377-0897, or at awolanin@fraserlawfirm.com.

The CARES Act Will Lead to More Small Business Bankruptcies—Here’s How to Protect Your Business from Getting Burned

JCPenney, Neiman Marcus, and other household names have recently filed headline-grabbing Chapter 11 bankruptcy cases. From energy to hospitality to retail, the COVID-19 crisis has had a devastating economic impact on a wide range of companies across industries. And, of course, small businesses are no exception. According to a survey conducted by the National Federation of Independent Businesses, “92% of small employers are negatively impacted by the outbreak of the novel coronavirus.”

While Chapter 11 bankruptcy has historically not been an option for most struggling small businesses due to the expense and complexity of the process, that may be changing as a result of recent legislation. What does that mean for all of the solvent businesses out there? They may be forced to deal with more of their business debtors inside of bankruptcy court, rather than through traditional debt collection means. In this article, we address recent changes ushered in by the Coronavirus Aid Relief and Economic Security Act (CARES Act), and provide businesses with advice on what to be prepared for and how they can protect themselves in this time of economic uncertainty, including:

Signs of customer distress
Protect yourself and help ensure payment going forward
What to do upon receipt of a notice of bankruptcy filing

Implications of the Small Business Reorganization Act

A case filed under Chapter 11 of the U.S. Bankruptcy Code is often referred to as a “reorganization bankruptcy.” On August 23, 2019, the Small Business Reorganization Act (SBRA), which added Subchapter V to Chapter 11 of the Bankruptcy Code, was signed into law and became effective on February 19, 2020.

SBRA streamlined the Chapter 11 bankruptcy procedure—allowing it to proceed more quickly and less expensively—for small business debtors with debts totaling up to $2,725,625. The CARES Act, which went into effect on March 27, 2020, temporarily (for one year) raised the debt threshold for SBRA filing eligibility to $7,500,000.

The SBRA makes the process for reorganizing under Chapter 11 more streamlined by shortening deadlines for various case filings, appointing a standing trustee in every case to facilitate the debtor’s dealings with creditors and keep the proceeding on track, not appointing a creditors’ committee in most cases, and not requiring debtors to pay quarterly U.S Trustee’s fees. In addition:

The debtor is the only party permitted to file a plan of reorganization.
The debtor is not required to file a disclosure statement unless ordered to.
A plan of reorganization can be approved even if all impaired classes of creditors object.
Individual debtors who have used home mortgages to finance their businesses have a right to modify those mortgage loans through a plan of reorganization.
Debtors may retain ownership of their business, even if the plan of reorganization does not fully repay unsecured creditors. In other words, the “absolute priority” rule does not apply under Subchapter V.

By raising the debt limit, and making other debtor-friendly changes through the SBRA, Congress made the streamlined Chapter 11 bankruptcy process available to significantly more small business debtors. Debtors have a new tool available to them to restructure their debts, which means their creditors, many of whom are facing their own financial challenges, need to be even more vigilant.

Spotting Signs of Customer Distress

As a supplier of goods or services, there are certain telltale signs you should be on the lookout for to determine whether your customers are experiencing financial distress. Missed payments, requests to modify contract terms, lack of communication, and an increase in collection activity (such as the filing of lawsuits) against a business are all indicators that a business may be struggling to pay its bills.

To help guard against risks, develop and implement internal procedures that will alert you when payments are being made outside of normal trade terms—or not being made at all. While many businesses are making accommodations to their customers right now, going deeper in the hole with a customer often doesn’t make sense if it’s putting your own cash flow at risk. Before taking any steps to accommodate a customer, consult with legal counsel to make sure that you are, first and foremost, protecting yourself.

Protect Yourself and Help Ensure Payment Going Forward

Once you’ve identified signs of potential distress, take steps to minimize the risks moving forward. It’s important to move quickly, and in consultation with legal counsel, because once a customer files for bankruptcy protection, there is little you can do to improve your likelihood of being paid relative to other creditors.

Require Cash in Advance

One of the simplest and most straightforward ways to ensure payment from a customer is to require cash in advance before supplying goods or services. In some cases, this may require the renegotiation of an existing contract. To the extent your customer is not currently paying in accordance with the terms of an existing contract, you may have the right to suspend your own performance, which can give way to discussions regarding new payment terms. An added benefit of requiring cash in advance of performance is that it can mitigate risks associated with preference lawsuits should your customer ultimately file for bankruptcy.

Requests for Adequate Assurance

If you suspect that a customer may be, or may become, unable to perform under a contract for the sale of goods, but is not yet in breach, you may want to consider demanding adequate assurance. Under Section 2-609 of the Uniform Commercial Code, a party to a contract has the right to demand adequate assurance of performance from a distressed contract counterparty. If the counterparty fails to provide adequate assurance, you may be able to repudiate the contract.

Request Other Forms of Financial Assurance

Explore with your legal counsel whether it’s advisable to seek various forms of financial assurance from a customer, such as obtaining a security deposit, letter of credit, or collateral to secure a debt. Depending on the product or service you supply to a customer, you may also be able to exercise a statutory lien, such as a construction lien, or a special tooling lien, in certain circumstances.

What to Do Upon Receipt of a Notice of Bankruptcy Filing

Regardless of how diligent you may be, today’s severe economic downturn makes it likely that you will be forced to deal with certain debtors in bankruptcy court. The new Small Business Reorganization Act only increases that likelihood.

Once you become aware of a customer’s bankruptcy, call your lawyer for advice. The “automatic stay” imposed once a debtor files for bankruptcy means that normal collection activity against a debtor must stop, and you can put yourself at risk of penalty by engaging in such activity. That doesn’t mean, however, that you must sit idly by during a customer’s bankruptcy. There are additional protections that may be available once the bankruptcy has commenced.

The creditors’ rights attorneys at Fraser Trebilcock are up to date on the latest developments in the bankruptcy laws, and we are seasoned Bankruptcy Court litigators. Experience has shown us that favorable results for creditors are possible within the constraints of the bankruptcy laws. For instance, a small business debtor’s reorganization in bankruptcy may allow repayment to creditors in situations where the debtor would otherwise have just shuttered its business and paid nothing. For assistance in dealing with a financially distressed customer, inside or outside of bankruptcy, please contact a Fraser Trebilcock attorney.

Fraser Trebilcock attorney Amanda S. Wolanin specializes her practice in business and tax law, bankruptcy, family law, estate planning, litigation, and real estate law. You can reach her at (517) 377-0897, or at awolanin@fraserlawfirm.com.