The Path to Legal Bankruptcy : Depending on Creditors, It Can Be Long, Intricate Process
Businesses, like the people who run them, have their ups and downs.
In Orange County, companies that are really on the way down often turn to the bankruptcy courts for relief.
When that happens, lawyers like Marc J. Winthrop go to work.
Winthrop is a partner in Lobel, Winthrop & Broker, one of the county’s major insolvency law firms, formed only 30 months ago in an amicable breaking away from McKittrick, Jackson, Demarco & Peckenpaugh in Newport Beach.
Now, ensconced in brand-new offices on the 11th floor of the black-glass Brinderson Towers building in Irvine, Lobel, Winthrop & Broker, with 17 attorneys, is handling several dozen cases--of which more than a dozen, including Maui & Sons, Irvine Ranch Markets and Heidi’s Frogen Yozurt, are considered major Chapter 11 reorganizations.
In most cases, Winthrop and his partners and associates shepherd clients through the bankruptcy courts. Winthrop looks at the process as the legal equivalent of major surgery--an often painful process that uses drastic measures to rescue patients from life-threatening ailments. It is something the 40-year-old attorney has been doing since graduation from UCLA law school 15 years ago.
Prompted by the recent Chapter 11 bankruptcy filing of American Continental Corp.--an action that left tens of thousands of Southern Californians holding $200 million worth of ACC bonds and wondering about their rights under bankruptcy law--Times staff writer John O’Dell recently discussed the workings of the Chapter 11 reorganization process with Winthrop.
Q. What are the classes and priorities of creditors in a Chapter 11 bankruptcy reorganization?
A. At the top is a secured creditor who can look to a particular asset, like a piece of machinery or real estate, to satisfy a claim. Then there are several classes of priority creditors--administrative, for professional fees, rent to landlords and goods and services acquired during the life of the bankruptcy case; gap claims that arise between the filing of an involuntary bankruptcy procedure and the granting of the order that puts the company into Chapter 11; employee wage claims of $2,000 or less incurred within the 90 days prior to the filing of the petition or the cessation of the debtor’s business; claims for contributions to employee benefit plans, with similar limitations; consumer deposits against the purchase of goods and services, to a maximum of $900, and finally, taxes owed to government entities.
Q. Where do the unsecured creditors come in?
A. At the bottom, after the priority creditors, come the general unsecured claims for just about anything--suppliers, unsecured lenders, bondholders, debentures holders, providers of goods and services.
Q. While you can file for bankruptcy on your own or be forced into it by your creditors, you are not actually bankrupt until the court orders it, correct?
A. Not quite. When you file your own petition, that is considered proof of bankruptcy, and you are in--unless a creditor or other interested party successfully challenges you. But if creditors are trying to force a company into bankruptcy, then there is a screening by the court. In an involuntary proceeding, you are an alleged debtor and the court ultimately holds a trial to determine whether or not you ought to be in Chapter 11 or Chapter 7.
Q. Once you are in, is it easy to get out?
A. No. The cliche is that bankruptcy is a bell that’s very hard to unring. You can voluntarily enter, but you cannot voluntarily exit. To get out before the process is completed takes a court hearing at which all your creditors and other parties with an interest in the proceedings can testify.
Q. Are bankruptcies almost always filed because the company has more debt than it can manage?
A. There are as many reasons for filing for bankruptcy as there are companies. Undercapitalization of an operating company is one--you have a lot of orders for widgets but you can’t afford the raw materials to make them. Other big reasons are mismanagement and catastrophic events like judgments in product liability or patent infringement lawsuits.
Q. Given that just about anyone can file for Chapter 11, how much abuse is there in the system? How often are bankruptcies filed for reasons that have little to do with debt repayment problems?
A. To a certain extent, abuse is in the mind of the abused. There probably are some who believe that all bankruptcies are frauds . . . (and) want to bring back debtor prison. Certainly there are some abuses of the system, but it is more often at the consumer level than with corporate reorganization. The abuses we see are things like consumers trying to stop evictions or foreclosures by transferring the property from one person to another and then filing bankruptcy petitions to get the automatic protection from foreclosure while the court takes weeks or months to find the case and kick it out. At the corporate level, the most typical (abuse) is the transfer of assets from one company to another on the eve of a filing.
Q. I raised the issue because of allegations in the American Continental Corp. case that the real reason Chapter 11 petitions were filed for the company and 11 subsidiaries of its Lincoln Savings & Loan Assn. was to shield assets from federal control when the S&L; was seized.
A. There are a large number of proceedings filed each year in which the real issue is not a company’s ability to service its debt but where there is a real and appropriate concern by the company to conserve its value as a going concern and to be able to rehabilitate itself. Quite often we see real estate company filings where the assets exceed the liabilities, but it still is appropriate if the purpose of the reorganization is to obtain time to recognize the fair value of the property. The fact that there is a strategy involved in a bankruptcy filing does not necessarily imply that there is a fraud.
Q. But is there room in the system for fraudulent filings, or do they pretty much get caught and kicked out?
A. The system doesn’t catch everything because it can’t. The function of determining the viability of a bankruptcy claim, for example, has largely been taken away from bankruptcy judges and shifted to the Office of the U.S. Trustee, which was formed in 1979 to perform oversight and monitoring functions and assume many of the administrative duties then held by the bankruptcy judges.
Q. How do you establish that you are a creditor in a bankruptcy?
A. In a Chapter 11, the debtor is required to file schedules of assets and liabilities and a statement of affairs within 15 days (of the case filing). This must list all liabilities, including unsecured debt. If a creditor is listed and agrees with the amount of debt listed, and there is no notation that the debt is disputed, contingent or unliquidated, then that creditor need do nothing further. The claim is deemed allowed and is taken care of in the course of the proceeding.
Q. What if you are not listed on the schedule of liabilities but believe you should be?
A. If a creditor is not listed, or doesn’t agree with the amount of debt shown, or is denoted as being unliquidated, disputed or contingent, then it is incumbent on that creditor to file what is known as a proof of claim.
Q. You just send a letter to the court?
A. Don’t send a letter. Get the appropriate form from the bankruptcy court or the legal forms department at you local stationery store. It is called a proof of claim. You fill it out, attach appropriate documentation of your claim and file it with the court.
Q. And then the court decides whether you should be added to the list?
A. No. You are automatically put on the claims docket. Once you file a claim, it is deemed allowed unless and until the debtor objects to it.
Q. How active can a creditor be, or expect to be, in a Chapter 11 proceeding?
A. A small creditor hasn’t got much to do but sit and wait and monitor the proceedings. The 20 largest unsecured creditors, however, get invited to meet and are asked to serve on a creditors committee.
Q. So that committee is only for the largest creditors?
A. In theory, it is made up of the seven largest creditors who are willing to serve. But it can be as small as three or big as 12.
Q. Can a large group of small creditors--like a company’s individual bond and debenture holders--get together, form an association and then claim membership on the creditors committee because, as a group, they are one of the largest creditors?
A. I’ve never seen it happen. But the creditors committee is supposed to be representative of the types of claims in the case, and the U.S. Trustee doesn’t have to put only the largest creditors on the committee.
Q. What goes into a company’s reorganization plan in a Chapter 11 proceeding?
A. For operating businesses, the classic plan is an internal one in which the company can operate and make a profit to fund the plan. There also is an external plan, which requires an infusion of capital from the outside, from a new investor or new lender or the sale of the company or some of its parts. Sometimes, Chapter 11s are filed just to facilitate the sale of a company or some of its assets. That happens when a company is in bad shape with suits and attachments and creditors hanging all over it so that nobody in their right mind would buy it and rely on the owners’ representations and warranties that all debts and suits been disclosed. If you put it in Chapter 11, the court has extraordinary power to sell assets free and clear of liens.
Q. Does the reorganization plan discuss how creditors are to be paid?
A. Once you have decided on an internal or external plan, then you deal with restructuring of debt. There are composition plans, in which you propose to pay less than 100 cents on the dollar, extension plans that extend the debt repayment over time, equity conversion plans in which creditors get stock in the company for their debt, or a combination of extension and composition, or even all three, so you propose to pay less than 100 cents on the dollar, plus stock, over a period of time. The type of payment is limited only by the creativity of counsel.
Q. What are the court’s guidelines in acting on a plan of reorganization?
A. The two basic standards are the best interests of the creditors and the feasibility of the plan. The court wants to ensure that the creditors are getting more than they would receive through liquidation and that the debtor isn’t promising more than it can deliver. It is one thing to say you are going to repay 100 cents on the dollar, but can you really do it?
Q. Is the reorganization plan developed by the company and its creditors together?
A. Ideally, they work in conjunction. But it can be done by one or the other. One of the common misconceptions about Chapter 11 bankruptcy is that there is a 120-day limit on filing the reorganization plan. Actually, there is no time limit. But the debtor has an exclusive period of 120 days during which only it can propose a plan.
Q. And if it doesn’t, then the creditors can?
A. Then any party-in-interest can.
Q. What is a party-in-interest?
A. A party that has a vested interest in the proceeding, as recognized by the court. In any bankruptcy, you have a debtor--what used to be called the bankrupt--and the creditors, the creditors committee and the office of the U.S. Trustee. The creditors are the primary parties-in-interest, although are some peripherally involved as contingent creditors, like an insurer. You can also have equity security holders and an equity security holders committee acting as parties in interest.
Q. Is it usual that creditors in a bankruptcy get repaid in full?
A. It is very unusual.
Q. If the creditors bitterly object to a plan, can the judge still approve it and force them to accept it?
A. No, it’s not that simple. There is a confirmation process. The creditors committee is set up to allow negotiation between the debtor and creditors, and sometimes there are other committees, like equity securities and bondholders. The desire is to come up with a negotiated plan. The code requires that a plan must be accepted by at least 50% in number and 66% in dollars worth of debt of the creditors voting in each class. That means that if there are 100 creditors in one class and only three vote and two of them vote to accept it and their claims represent at least two-thirds of what is owed to the three voters, then the plan is accepted by that class, even though 97% didn’t vote. If it is not accepted by each of the classes, then the debtor can request that the court cram the plan down. A cram-down is a very esoteric procedure; we could do another couple of hours interviewing on it. But basically, it means that the judge can confirm the plan over objections if at least one class of creditor accepts it. In no case can you cram down a plan that all classes are opposed to.
