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1. Insolvency and restructuring procedures
1.1 – What are the main insolvency and restructuring procedures applicable to companies?
- Bankruptcy Liquidation
- Bankruptcy Reorganization
Liquidation – a company may petition the bankruptcy court for protection under chapter 7 of the US Bankruptcy Code, or a small group of creditors may petition for an involuntary bankruptcy. A petition filed under chapter 7 of the Bankruptcy Code results in the appointment of an independent bankruptcy trustee who is vested with maximizing value from the company’s assets for the benefit of creditors. Though the default rule is that a bankruptcy trustee will cease all of the company’s operations and commence of the liquidation of the company’s assets the trustee may, in limited circumstances, obtain authority to operate the company while liquidating its assets. A case under chapter 11 of the Bankruptcy Code – which is nominally reserved for reorganizations – may sometimes be used for liquidation or going-concern sales as well.
In addition to liquidating in bankruptcy, a company may also liquidate voluntarily outside of bankruptcy under court auspices (eg, receivership) or without court supervision (eg, assignment for the benefit of creditors).
Reorganization – a financially distressed entity may file a petition in bankruptcy court for protection under chapter 11 of the US Bankruptcy Code. Insolvency is not required. In a case under chapter 11 of the Bankruptcy Code, the pre-existing management typically remains in control of the entity and assumes the fiduciary duties otherwise charged to a bankruptcy trustee. The default rule in chapter 11 is that the company will continue operating while it seeks to maximize value through a going-concern sale or confirmation of a Plan of Reorganization. A Plan of Reorganization is a court-approved agreement that address the treatment/satisfaction of claims. The Plan of Reorganization must be confirmed by the bankruptcy court, which applies certain codified legal requirements, including consideration of the outcome of a vote of creditors. Certain entities (eg, banks, insurance companies) are not eligible for bankruptcy but may liquidated through other processes.
1.2 – Can a company obtain a moratorium whilst it prepares a restructuring plan? If so, what is the effect of the moratorium?
Yes. Immediately upon the commencement of any bankruptcy case (whether under chapter 7 or chapter 11), US law imposes an “automatic stay”, which enjoins a wide variety of actions by creditors and other parties against property of the company’s bankruptcy estate. Unless the court modifies the stay upon a creditor’s establishment of certain statutory requirements, the stay continues until the confirmation of a chapter 11 Plan, or the closing of the bankruptcy case.
1.3 – How long will it generally take for a creditor to achieve the liquidation of an insolvent company, assuming an undisputed claim and no opposition from the company?
To liquidate in bankruptcy, unless the debtor is especially small, the creditor will often be required to find two additional creditors (known as “petitioning creditors”) to join in the involuntary bankruptcy petition who also have non-disputed and non-contingent claims. Assuming that the required number of creditors holding claims in excess of a proscribed dollar amount (approximately US$15,000) file an involuntary petition, the company will have four weeks to oppose the formal commencement of the bankruptcy case. If not opposed, or if the petitioning creditors establish that the company is not generally paying its debts as they come due, a bankruptcy trustee will be appointment to commence the liquidation of the company. A judgment creditor may seek liquidation if no bankruptcy is filed; the timetable will vary considerably.
1.4 – Does your jurisdiction make use of a distressed sale process by which the business/assets of the company can be sold?
Yes, in the United States, there are several insolvency processes that can be used to facilitate the sale of entire businesses (as a going concern) or assets (including sales of substantially all assets).
In a formal bankruptcy case, under Section 363 of the United States Bankruptcy Code, a debtor can obtain authority to sell some or all of its assets, free and clear of all liens, claims and encumbrances. This process enables debtors to maximize value for stakeholders because it (1) allows for a streamlined method of liquidating assets and (2) enables a buyer to acquire assets free and clear of claims, including successor-liability claims. The Section 363 process typically involves competitive bidding overseen by the bankruptcy court, ensuring transparency and fairness. This competitive nature, and the ability to obtain a court order providing for the free and clear sale, often drives up the sale price. Ultimately, Section 363 sales provide a structured and efficient mechanism to maximize asset value, offering a clear path to recovery for financially distressed businesses.
2. Insolvency office-holders and courts
2.1 – Who can act as an insolvency office-holder?
In a chapter 7 bankruptcy case, the insolvency office-holder is a bankruptcy trustee. The trustee is chosen from a local panel of trustees approved by the US Department of Justice’s United States Trustee program.
In a chapter 11 bankruptcy case, typically the company continues in possession of its assets, with existing management charged with the fiduciary duties that would otherwise be charged to a trustee. Although there is a modern trend with large companies to appoint a Chief Restructuring Officer who is familiar with the bankruptcy process, this is not required by the Bankruptcy Code. In a chapter 11 case in which the court determines that there has been fraud or gross mismanagement, then a bankruptcy trustee is appointed by the court, but not necessarily from the same local panel of trustees.
2.2 – Who decides the identity of the insolvency office-holder, and what restrictions apply?
The trustee is appointed by the Office of the United States Trustee, which is an arm of the US Department of Justice.
2.3 – Are insolvency cases heard by specialist judges, or in the general commercial courts?
Bankruptcy cases are heard by specialist judges. Non-bankruptcy liquidations are not overseen by specialist judges.
3. Position of directors
3.1 – To what extent do the directors of the company remain in control of its affairs during any of the procedures described above?
In a chapter 7 bankruptcy case, existing management is relieved of its duties immediately upon the appointment of a trustee. In most chapter 11 bankruptcy cases – assuming no fraud or gross mismanagement – the existing management remains in place and continues to control management decisions.
3.2 – Are there circumstances in which directors are obliged to file for insolvency proceedings? If so, when do those circumstances arise?
There is no duty to commence a bankruptcy case. However, there are circumstances in which existing management would voluntarily file a bankruptcy petition. The officers and directors are charged with fiduciary duties toward creditors once a company is insolvent. If filing a bankruptcy petition is in the best interests of creditors once the company is insolvent, then the officers and directors would be expected to do so.
3.3 – What are the risks facing the directors of an insolvent company?
US state laws allow for claims against directors if they have breached their fiduciary duties to the company. The level of risk will generally vary, based on applicable state law and the terms of the company’s governing documents.
4. Position of creditors
4.1 – What are the main forms of security over movable and immovable property?
Security over movable property is generally taken by:
- security interest under Article Nine of the Uniform Commercial Code
Security over immovable property is taken by:
- mortgage and deeds to secure debt
4.2 – How does the opening of insolvency proceedings affect the rights of secured creditors?
Secured creditors are subject to the automatic stay and are generally expected to wait through the proceedings before realizing value. Though the Bankruptcy Code provides that secured creditors should generally receive 100% of the value of their collateral at the end of the proceedings, lenders are often forced to fund the case out of their collateral.
4.3 – Where a debt owed to a secured creditor exceeds the value of the security, is the secured creditor entitled to claim for the shortfall?
Yes, but the claim for the shortfall would be unsecured.
4.4 – Which classes of creditor are given preferential status? Are any classes subordinated?
Under the Bankruptcy Code, secured claims are first in priority and, thus, are supposed to receive payment in full or to retain the property interest after the bankruptcy case. After satisfaction of secured claims, the following classes of claims are generally given priority:
- administrative expenses of the bankruptcy estate
- unsecured claims in an involuntary bankruptcy, arising in the ordinary course of business between the filing of the bankruptcy petition and the order for relief
- certain claims related to employee wages
- claims related to contributions to employee benefit plans
- certain tax claims
There are no specific types of creditors or claims that must be subordinated. The bankruptcy court will generally respect parties’ agreements to subordinate certain claims, such as in intercreditor agreements. In addition, the bankruptcy court has power to subordinate claims for inequitable conduct. As noted above lenders are often forced to fund the case out of their collateral and, thus, subordinate their claim to administrative claims.
4.5 – Is there a date by which creditors must make claims in the insolvency proceedings? If so, what are the consequences of failing to claim by that date?
In a chapter 7 liquidation, creditors must file claims within 70 days of the commencement of the case. In a chapter 11 bankruptcy case, there is no statutory requirement and therefore the deadline will vary.
Failure to file a claim by the deadline will almost always result in a bar from recovery from the bankruptcy estate.
4.6 – Are contractual rights of set-off and/or netting effective in insolvency?
Contractual rights of set-off and/or netting are generally allowable, subject to a few additional requirements that would not be imposed outside of bankruptcy. First, the set-off or netting may not always be exercised immediately. Second, the rights may only be exercised at the end of the proceedings unless court approval is obtained. Third, only mutual debts (i.e., debts owing between the same parties) are subject to setoff.
4.7 – Are contract terms permitting termination of a contract by reason of insolvency (“ipso facto clauses”) effective?
No. Except for certain contracts related to financial or commodity trading, ipso facto clauses are unenforceable.
4.8 – Are retention of title clauses enforceable and (if applicable) what are the main requirements for enforceability?
Yes, but only if the creditor complies with the security interest requirements of the Uniform Commercial Code.
4.9 – Are foreign creditors treated equally to domestic creditors?
Yes.
5. Setting aside transactions
5.1 – What are the main transaction avoidance provisions applicable to the proceedings referred to above?
The primary types of avoidance actions are preferences, fraudulent conveyances and unauthorized post-petition transfers. Preferences are generally transfers by the debtor in the ninety days prior to bankruptcy (one year when the transfer is to an insider), which enable one creditor to receive more than they would have received in a chapter 7 liquidation. Fraudulent conveyances may be transfers involving actual fraud upon creditors, or constructive fraud – the latter of which are transfers at a time when the debtor was insolvent or the like, for which it received less than reasonable equivalent value. As the name implies, unauthorized post-petition transfers are transfers of the bankruptcy estate for which the Bankruptcy Code required court approval and none was granted.
5.2 – Who is entitled to challenge transactions under these provisions?
A bankruptcy trustee or a chapter 11 debtor-in-possession may assert claims to avoid the transactions discussed above. Occasionally, an Official Committee of Unsecured Creditors will also be authorized to do so. Unsecured creditors may also seek authority to challenge these claims.
6. Cross-border insolvency
6.1 – Do your courts recognize insolvency proceedings commenced in the courts of other jurisdictions?
Yes, if the other jurisdiction is a signatory to the UNCITRAL Model Law on Cross Border Insolvency.
6.2 – If so, what assistance can your courts provide, following recognition?
Following recognition, the primary assistance is in the form of enjoining certain actions and marshalling assets within the US.
6.3 – Is it possible to commence insolvency proceedings in relation to a foreign company?
Yes.
7. Other matters
7.1 – Please consider whether there is any other feature of your country’s insolvency regime of which a lender, investor or purchasers of distressed debts or businesses should be aware? For example, are there any mistakes that foreign creditors often make?
It is valuable to arrange for local counsel in the jurisdiction of the proceedings, ideally as early as possible. There is a wide range of variation in local procedural rules and judges’ preferences, and local counsel will be able to help navigate those variations.
7.2 – Are there any other stakeholders or entities (eg governmental or regulatory) which may influence the outcome of any restructuring?
Yes, once a company files for bankruptcy under the Bankruptcy Code, there are several entities that can influence the outcome of the case. These include the Office of the United States Trustee, Official/Statutory Committees, parties-in-interest, and, depending on the business involved, other governmental regulatory regimes. First, the Office of the United States Trustee is a division of the Department of Justice is who responsible for ensuring that the Debtors and other stakeholders comply with the Bankruptcy Code during the pendency of the case. Second, by operation of the Bankruptcy Code, there are certain Official/Statutory Committees who are appointed to represent the interests of specific groups (for example, unsecured creditors). In addition to having a formal voice in bankruptcy cases, the fees and expenses of these entities are paid by the company in bankruptcy. Third, as bankruptcy is designed to be an open process, parties who may be affected by the case, including governmental regimes that may have oversight over the debtor’s business, are entitled to participate and raise objections as parties-in-interest.
7.3 – Are there currently any proposals for significant reform of your insolvency laws?
None pending at the moment, but there is a recent amendment to the Bankruptcy Code to make chapter 11 relief more readily available to smaller businesses. The threshold level of assets and liabilities for relief under that sub-chapter was lowered in responses to the COVID-19 pandemic.
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