MorrisAnderson

By Bobby Guy, Frost Brown Todd LLC.

There was a time in the late 1990s when bankruptcy lawyers joked it might be malpractice to file a Chapter 11 bankruptcy anywhere outside of Delaware. Like all good humor, it had some basis in the truth: A major advantage of Chapter 11 is that a company can file bankruptcy anywhere that one of its affiliates is incorporated or has so much as an equipment shack or one-person office it can call a principal place of business or principal asset. As a result, the business’ lawyers usually get a wide choice of places to initiate a Chapter 11, and at times, Delaware has been the most popular because of its sophistication and consistency. 

What are the major issues that go into choosing where to file a Chapter 11 case? A number of articles are published annually about the legal differences that distinguish bankruptcy courts from one another; instead of competing with those articles, the goal here is to examine the more practical issues and anecdotal examples that counsel, turnaround managers and the C-suite team should consider when choosing a venue.

Without a doubt, predictability is the issue that encompasses all other considerations. The Western legal system is based on it, and unpredictability is anathema to lawyers in all fields and their clients. When choosing venues for their bankruptcy proceedings, businesses can ensure a more predictable ride by considering the following elements:

Consistent and Responsive Courts

Filers should be wary of courts that do not have reasonably good and responsive first-day procedures. Nothing is worse than filing a Chapter 11 and not getting a first-day hearing for weeks or even months -- one West Coast company shut down several years ago after being forced to wait 10 days for a first-day hearing. Companies need to have first-day hearings promptly so that they can access cash, pay employees, continue centralized cash management and pay essential suppliers. Poor first-day hearing procedures can also signal a more general lack of responsiveness, a major stumbling block for operating companies in Chapter 11, which often need to schedule emergency or expedited hearings. Delaware and the Southern District of New York have led the way on first-day responsiveness and many other courts, such as the Southern District of Texas, have followed suit by adopting similar local rules and procedures.

Consistency in courts is also vital, not just on the law, but among judges as well. In a district with multiple judges, if drawing the wrong judge can result in a completely different outcome, the district is not likely to be a popular one. Highly consistent bankruptcy courts are sometimes dubbed “debtor-friendly,” but a better phrase would probably be “value- and-process-friendly.”

A Receptive and Flexible U.S. Trustee

In many jurisdictions, the U.S. Trustee’s office sees a constant flow of Chapter 11s, works with attorneys regularly and has clear policies about how to handle standard issues. Other U.S. Trustee offices may be much less experienced and less responsive to Chapter 11 cases, however. This is an important consideration, because skirmishes with the trustee can quickly become a thorn in the debtor’s side. Unlike private parties who have an incentive to settle, government employees approach the case solely from a precedent and policy standpoint, meaning the debtor can only offer logic to the U.S. Trustee to eliminate objections. 

Major issues to consider regarding U.S. Trustees are receptiveness to the “Jay Alix Protocol,” which sets limits on hiring advisors during the bankruptcy process that were involved in the company before the filing; the trustee’s stance on professional payments to advisory firms; and flexibility in how fees are allocated between debtors in a multisubsidiary case. Flexibility on cash management is especially important, since the company’s bank may be noncompliant with the bankruptcy bonding standards. In this event, unless the trustee is flexible for a few weeks while the debtor works with its bank to become compliant or moves accounts, serious disruption in a debtor’s business and cash flow can follow.  

Companies should also research the U.S. Trustee’s procedure and timing in appointing the unsecured creditors committee when choosing a bankruptcy venue. In general, quick selection and organization of the unsecured creditors committee is best for all parties involved. Timeliness varies by office: Some trustees handle this within 10 days, while others can take 30 days or more. Procedural details also vary from district to district. Some trustees appoint bondholders instead of indenture trustees to committees, for example, and some appoint different committees for separate debtors instead of a consolidated committee. 

Differences in Rulings Among Circuits

If anyone believes that the law is only a minor factor in deciding venue, consider the so-called “Capital Factors” decision by the U.S. Court of Appeals for the 7th Circuit that prohibited critical vendor payments in Kmart Corp.’s bankruptcy. Before that case, some were beginning to favor Chicago as a national venue for bankruptcies. Many argue that Capital Factors has sent subsequent major cases eastward. 

Major legal issues to consider in the venue decision include the ability to pay critical vendors, get third-party releases in a plan of reorganization, pay reasonable break-up fees and run quick “363” sales. A couple of anecdotal examples found off the beaten path are worth mentioning.

Many jurisdictions allow a lease guarantor to cap lease guaranty liability at one year, but other courts, such as the Northern District of Georgia, have found that lease guarantees are not capped. For national retailers or other debtors with significant lease obligations, filing in Georgia instead of another district could cost them potentially hundreds of millions of dollars. In addition, a court’s willingness to separately classify the deficiency claim of a secured creditor from other unsecured creditors can affect a company’s reorganization plan significantly. The U.S. Court of Appeals for the 6th Circuit, for example, has generally upheld separate classifications of a secured creditor’s deficiency claim, meaning that the debtor is often able to get the unsecured class to vote for the plan of reorganization, no matter how large the secured creditor’s remaining claim may be. This can be the difference between a confirmed plan and a conversion to Chapter 7 bankruptcy.

Keeping Expenses Reasonable

When it comes to expenses, venue makes a huge difference. Travel costs for lead counsel, accessibility of the forum by regular airline flights (Reno, anyone?), rules requiring the retention of local counsel and the rate structure of lawyers in the jurisdiction are all important considerations. A court’s willingness to handle hearings by proffers of evidence, instead of requiring lengthy witness testimony, and to conduct phone hearings on uncontested matters can also affect the bottom line significantly. For a midmarket client with $25 million in debt, the Southern District of New York might have favorable rules, but the rate structure of competent lawyers there could make any Chapter 11 short-lived.  

For the restructuring professionals involved in the case, knowing that a jurisdiction is reasonable about fee approval and receptive to out-of-town market rates and expertise is paramount. One Mississippi jurisdiction, for example, is known to cap Chapter 11 “reasonable” attorney rates at $275 an hour, a fee structure far below market rate for experienced bankruptcy lawyers in any other district. 

Disposing the DIP Lender

Everyone knows companies need money to reorganize. That’s why the approval of a debtor-in-possession (DIP) lender, which extends credit to companies in Chapter 11, often overrides other venue concerns. The DIP lender’s considerations include the likelihood that the DIP loan will be approved as negotiated; the reasonableness of any carve-outs the court imposes; whether the court will enforce the DIP loan if the debtor defaults; the ability to roll up the company’s pre-bankruptcy debt; and the DIP lender’s ability to get its own fees approved at reasonable levels. 

Because the DIP lender holds the cash, it generally makes the rules about where to file the case. Many are the cases that were prepared for one venue, only to be changed at the last minute to accommodate a newfound DIP lender’s demands. 

Making Venues Work for You    

With all the venue options for bankruptcy filing at a company’s disposal, choosing the right place to reorganize can be daunting. But maximizing predictability by thoroughly researching all the aspects of a particular venue can go a long way toward the success of a company’s restructuring, as well as its future.

Bobby Guy is a member of Frost Brown Todd LLC and works from the law firm’s Nashville, Tenn., office. He specializes in returning struggling companies to profitability and helping companies and funds buy distressed assets. He is listed in Best Lawyers® in America, Super Lawyers® and the American Board of Certification’s list of business bankruptcy lawyers. He can be reached at bguy@fbtlaw.com or (615) 251-5557.