Common Bankruptcy Issues: How to Mitigate Risk

1. Common Bankruptcy Issues:How to Mitigate Risk Presentation to Association of Corporate Counsel (ACC) Small Law Department Committee on May 13, 2010 by Amy Swedberg (612) 672-8367 amy.swedberg@maslon.com Maslon Edelman Borman & Brand, LLP 3300 Wells Fargo Center Minneapolis, MN 55402 www.maslon.com

2. Pre-Bankruptcy Tools to Mitigate Risk Purchase Money Security Interest (PMSI) • Need signed security agreement or reservation of title in sales document • UCC § 9-324 governs perfection rules • UCC filed within 20 days of delivery • Advance written notice to blanket secured lender if goods are inventory • Insider or Affiliate Guaranty, Letter of Credit, Customer Deposit Agreement • Security Interest in Other Assets 2

3. Pre-Bankruptcy Tools to Mitigate Risk Preference Risk (90 days) • TIP: Aggressive payment terms (due upon receipt) or collection action could create more risk; payment consistency is important for proof of the ordinary course of business defense Vendor Bankruptcy • Prior to bankruptcy file precautionary UCC-1 on tooling or other assets located at the vendor • No right to terminate executory supply or other executory agreements after bankruptcy filing; bankruptcy termination or ipso facto clauses are unenforceable 3

4. Locating a Bankruptcy Filing • Court info: www.uscourts.gov/courtlinks • TIP: www.nysb.uscourts.gov (all courts use 2 letter state code, followed by one letter code, e.g. “s” for southern,“w” for western, “c” for central, if applicable, then “b” for bankruptcy) • Search for bankruptcy filings in states where debtor is “located” (incorporated or organized) or debtor’s principal place of business • Register for PACER log-in and password at https://pacer.login.uscourts.gov • Log on to websites at “ecf.” instead of “www.” https://ecf.nysb.uscourts.gov 4

5. Types of Bankruptcy Filings • Chapter 11 • Debtor remains in possession and control of its property and operates in the ordinary course of business • Debtor seeks confirmation of Ch. 11 plan (120 day exclusive right to file plan, can be extended for “cause” up to 18 months) or sells assets in § 363 sale followed by liquidating plan or conversion to Ch. 7 • Chapter 7 • Ch. 7 trustee has possession and control of assets and liquidates and distributes according to priorities under bankruptcy code • Only individuals have property exemptions • Chapter 13 • Debtor proposes Ch. 13 repayment plan upon filing 5

6. Priority of Payment in Bankruptcy • Secured Claims(to extent of value of collateral) • Ch. 7 Priority Claims(after conversion from Ch. 11) • Ch. 7 trustee fees, expenses of liquidation and necessary to preservation of property • Ch. 11 Priority Claims • Post-petition administrative expenses necessary for the debtor to operate in Ch. 11 under 11 U.S.C. § 503(b) • Certain taxes/wages and other priority claims • 20-day claims under 11 U.S.C. § 503(b)(9) • Unsecured Claims • Equity • Equity may keep interests and pay less than 100% to unsecured creditors under “new value” plan 6

7. Common Bankruptcy Issues Executory Contract Issues (11 U.S.C. § 365) • Some performance remains due on both sides at the time of the bankruptcy filing; debtor can assume or reject in bankruptcy • Non-debtor has duty to continue performing prior to rejection of executory contract; debtor generally controls timing of assumption / rejection decision • Non-debtor has right to adequate protection including post-petition payments/performance or may seek to compel rejection • Assumption requires full cure; must be assumed “as is” • Contract may generally be assigned notwithstanding anti-assignment clause; non-debtor has right of adequate assurances of future performance 7

8. Common Bankruptcy Issues File Proof of Claim (POC) • Use POC form mailed to creditors or pull form from bankruptcy court website; mail copy with self-addressed, stamped envelope for proof of receipt • Most Ch. 7 case are filed as “no asset” cases, notice will state Please Do Not File a Proof of Claim Unless Instructed To Do So • Watch for Claims Agents and POC Bar Dates; last day to file claims is generally 90 days after Meeting of Creditors except larger Ch. 11 cases where the bar date is set by motion and court order 8

9. Common Bankruptcy Issues Evaluate Preference Risk Bankruptcy Code § 547(b) defines a preference as: • a transfer of the debtor’s interest in its property, • to or for the benefit of a creditor, • on account of an antecedent or existing debt, • made while the debtor was insolvent, and • on or within 90 days prior to the petition date (or one year for insiders) that enables the creditor to receive more than it would in a Ch. 7 liquidation 9

10. Common Bankruptcy Issues Evaluate Preference Defenses • Ordinary Course of Business (OCB) • subject or objective test • Subsequent New Value • “paid for” new value, emerging view recognized in most jurisdictions • Contemporaneous Exchange of Value • Assumption of Executory Contract / Critical Vendor • Small Preference Safe Harbor (<$5,475) • Venue limitation (<$10,950) • TIP: Ignore demand letters, you may not be sued, but watch for summons & complaint to arrive by regular mail 10

11. Common Bankruptcy Issues Immediately Pursue Reclamation Rights BAPCPA expanded rights under 11 U.S.C. § 546(c) • Seller may not reclaim goods unless such seller demands in writing reclamation of such goods— • not later than 45 days after the date of receipt of such goods by the debtor; or • not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case 11

12. Common Bankruptcy Issues Reclamation Rights(continued) • Requires written reclamation notice • Goods must still be in existence and identifiable • May receive return of goods • Reclamation procedures sometimes addressed in “first day” orders • Secured lender will almost always have priority which diminishes the effectiveness of most reclamation claims 12

13. Common Bankruptcy Issues Intellectual Property Issues Non-debtor as Licensor / Debtor as Licensee • Customer may assign its licensee rights to a third-party notwithstanding anti-assignment clause • non-debtor should object if licensee rights are non-exclusive; non-exclusive rights are viewed as personal and generally cannot be assumed and assigned • TIPS: non-debtor should demand immediate payment of post-petition royalties instead of administrative expense claim due to risk of administrative insolvency 13

14. Common Bankruptcy Issues Intellectual Property Issues(continued) Debtor as Licensor / Non-Debtor as Licensee • Non-debtor may elect to retain licensee rights, including exclusivity, for duration of contract and any extension under Bankruptcy Code § 365(n) • Does not apply to trade names or trademarks • Requires non-debtor to make all ongoing royalty payments • TIPS: Support licensee rights with lien on IP; place source code in escrow; distinguish between maintenance and royalty payments; avoid high up front payments or anything that encourages rejection 14

15. Common Bankruptcy Issues Secured Lien Rights • Secured creditor has right to “adequate protection” of its lien in collateral valued as of the petition date • Secured creditor can seek relief from the automatic stay to foreclose on its collateral • For “cause” including lack of adequate protection • No equity in collateral and collateral not necessary to an effective reorganization • Secured creditor entitled to lien on sales proceeds, return of collateral or “indubitable equivalent” • Junior secured creditor may have leverage even with “out of the money” junior lien under recent 9th Circuit Clear Channel decision, 391 B.R. 25 (9th Cir. BAP 2008) 15

16. Common Bankruptcy Issues Evaluate Priority Admin. Expense Claims • Code § 503(b): Priority administrative expense claim for post-petition goods or services necessary for continued operation or preservation of estate assets • §503(b)(9) Claim: Available if client supplied goods in the ordinary course of business 20 days prior to petition date • Generally client must file motion for allowance of 503(b)(9) claim if no alternate procedure is specified • Procedures or deadlines for asserting may be addressed in “first day” or other Bankruptcy Court orders • Watch for deadline earlier than general claims bar date • 503(b)(9) claim may not be paid until plan confirmation 16

17. Common Bankruptcy Issues Setoff Rights(11 U.S.C. § 553) • Preserves non-debtor’s common law right to offset mutual debts • Available only if mutual obligations are both pre-petition or both post-petition • Requires relief from the automatic stay and must be exercised prior to any sale “free and clear” under § 363 Equitable Recoupment • Debts must arise out of same transaction or occurrence • No stay relief necessary and may be asserted post-sale 17

18. Amy J. SwedbergPartnerMaslon Law Firm Phone: 612.672.8367 Email: amy.swedberg@maslon.com www.maslon.com AREAS OF EMPHASIS • Banking and Financial Services • Creditor’s Rights and Bankruptcy • Indenture Trustee Representation • Secured Lending Amy Swedberg is a partner in Maslon's Financial Services Group. Her practice focuses primarily on the representation of financial institutions, secured creditors and equipment lessors in workouts, collection litigation and bankruptcy, as well as indenture trustees in complex Chapter 11 proceedings. She also assists corporate counsel on bankruptcy and collection related issues and asset-based lenders in preparing and negotiating commercial loan documentation. Prior to joining the firm in 2000, Amy gained valuable experience practicing as a civil and commercial litigator.