The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” (as the “Act”) becomes effective Monday, October 17, 2005, and represents the biggest overhaul of bankruptcy law in more than 25 years. The major thrust of the Act is to limit an individual debtor’s access to relief under chapter 7 of the bankruptcy code. Chapter 7 gives a debtor the right legally to discharge most debts after the debtor’s non-exempt property is turned over to an appointed trustee for liquidation.

Under the new Act, access to relief under chapter 7 will be restricted. Individuals with income above their state’s median who can pay at least $6,000 to their creditors over a five year period will be required to file under chapter 13 of the bankruptcy code, and will not be eligible for chapter 7. Chapter 13 mandates that a debtor pay creditors pursuant to a court approved plan based on a debtor’s available cash after deducting reasonable living expenses.

While the focus of the Act, and much of the publicity surrounding the Act’s passage, has centered on its consumer provisions, numerous other changes have been made to the bankruptcy laws that govern chapter 11 business reorganizations.

Under the Act, the rights of chapter 11 debtors have been modified as follows:

  • A debtor’s exclusive right to file a plan of reorganization may not be extended by the bankruptcy court beyond 18 months. After that, other parties in interest may submit reorganization plans.
  • A debtor in possession may assume an unexpired lease of nonresidential real property before the earlier of 120 days after commencement of the case, or the date of plan confirmation. The court may extend that time for an additional 90 days, but any subsequent extension requires the landlord’s consent.
  • When a debtor assumes a nonresidential real property lease and subsequently rejects the lease, the landlord is entitled to an administrative claim for all monetary obligations due to the landlord for the next two years, without the right of setoff or reduction for any reason.
  • Where a personal property lease is not assumed in a chapter 11 plan, the lease is deemed rejected as a matter of law and the automatic stay is terminated without further order of the bankruptcy court.
  • A creditor’s right to reclaim goods delivered to an insolvent debtor is extended to cover goods delivered within 45 days of the bankruptcy filing. If the creditor fails to make timely demand for return of the goods, the creditor nevertheless is given an administrative claim for the value of any goods received by the debtor within 20 days before the date of commencement of the case.
  • A creditor’s defenses to a preference action brought by the bankruptcy estate are expanded to include payments made in the ordinary course of business or payments made according to ordinary business terms. The current law requires that both these factors be established in a successful defense.
  • Except in very narrowly drawn circumstances, retention bonus payments to a debtor’s officers and directors to induce them to stay with the business are curtailed. Severance payments to a debtor’s insiders are also severely limited.
  • Utility creditors may alter or refuse utility service to a debtor if within 30 days of the filing date the utility does not receive assurance of payment that is satisfactory to the utility.

This article sets forth only a few of the provisions relating to chapter 11 business cases that will affect both debtors and creditors now that the Act has become effective. Sheppard Mullin lawyers in the Finance and Bankruptcy Group welcome your questions and comments regarding these materials, and will be pleased to discuss this new legislation with you at your convenience. Please do not hesitate to give one of us a call.

Written by: Craig Stuppi

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