Day One After Filing - Short

Topics

• First-day motions
• Keeping & paying employees
• Critical vendors
• Owner's salary, bonuses & perks
• Family members' positions
• Monthly court reporting

Guest: Christopher A. Bailey — Holland & Knight\

This is an abridged version of the original episode. Feel free to go back and listen to the full version in our show feed.

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Transcript

SPEAKER_00 0:01

You are listening to Corporate Bankruptcy A to Z, a podcast that gives you the ins and outs of corporate bankruptcy. This is an abbreviated release of episode 8, where we will cover what changes immediately after filing, including court approvals, first day motions, operating the business, use of cash collateral, and how employees and obligations are handled. If you are new to the show or want to hear the full conversation about this topic and more, we invite you to check out our full bankruptcy series found below in the show feed. There you will find an unedited version of each episode where we dig deeper and answer more questions. Corporate Bankruptcy A-Z is hosted by Neil Goldstein, a chief restructuring officer with over 30 years experience. He's joined by co-host and legal expert Steve Raven of Saul Ewing, a bankruptcy attorney with over 40 years in the field. If you are dealing with a situation now and need guidance, you can reach out to them directly. Call Neil at 940-808-9451 and Steve at 973-286-6713.

SPEAKER_02 1:11

We have a special guest with us tonight, Chris Bailey of Holland and Knight. In this podcast, we have covered all aspects of getting the company filed. As you know, prior to submitting the petition, the company operated as it saw fit. That all changes with the filing, and this episode will address what happens at the company after the petition has been filed. So the paperwork has been presented to the court. What does the court do with that submission?

SPEAKER_03 1:43

You know, sophisticated debtors file much more than just a single petition, ranging from documents to provide disclosure, such as a list of the debtor's largest creditors. Additionally, at the time of filing, the debtor will often file a number of what we call first day motions because those motions are going to be heard on the first day you're in court. And those motions are asking for relief on an expedited basis to allow a debtor to continue to operate while in bankruptcy. Because, you know, as I'm sure you've you've discussed in other episodes as well, upon filing bankruptcy, kind of everything stops for the debtor, and you need court permission to start operating again. And so along with your petition and your disclosure documents, you file these first day motions. And when the court receives those, they're going to review everything that's filed. I I've I've never walked into a court and the judge hadn't read what was filed. I'm sure it happens sometimes, but most of the time the the court is is pretty caught up on why you're there and what you're asking.

SPEAKER_01 2:41

And the judge wants to do what's necessary to allow the debtor to remain operating, whether it's paying payroll or using the cash collateral, just the basics of what's necessary so that the debtor can get past the first 20 days when there is uh more scrutiny, more opportunities by other parties for questioning. So that's really the intent of this first day hearings.

SPEAKER_02 3:13

So immediately after the filing, can the company operate normally, paying bills, selling goods and services?

SPEAKER_03 3:21

Yes, but there is a nuance to that answer. Section 363 of the bankruptcy code authorizes a debtor to continue operating in the ordinary course of business, you know, performing transactions, etc., without court approval. As a general rule in bankruptcy, and there are exceptions to this rule as well, but as a general rule in bankruptcy, a debtor is not authorized to pay any debts that arose pre-petition. And so the debtor wouldn't be allowed to pay those debts after filing. And so the debtor is able to pay post-petition debts. And in fact, post-petition debts are given priority.

SPEAKER_02 3:57

One of the situations I run into quite often is uh what they call a mic drop. When I have to tell my client that they have to apply for cash collateral. Could you explain why that is and how it works?

SPEAKER_03 4:13

The start to answering that question is kind of explaining what cash collateral is. Cash collateral is a debtor's cash and cash equivalents that are subject to the lien of a secured creditor. Section 363 of the bankruptcy code states that a debtor is not allowed to use the cash collateral of a secured creditor absent that creditor's consent, or you know, otherwise having a court order saying that you can use that cash collateral.

SPEAKER_02 4:39

Which brings up the employees because the company's cash is needed to pay the employees so that the company can continue. What happens to the employees in that case? They continue to get paid?

SPEAKER_03 4:54

They do. So as previously discussed, when you file for bankruptcy, any obligation incurred post petition is entitled to kind of administrative expense status, meaning it gets priority of payment. And this would include wage payments to employees. And you know, I I've personally never seen that motion objected to. It's granted, you know, regularly as a matter of course. Not to say that never happens, just I've never seen it as it happen. And so even in that situation, an employee is typically going to be paid what they're owed, regardless of if it was earned pre-petition.

SPEAKER_02 5:28

If you stretch out the term employees, does that include contractors or how far can that stretch so key personnel get paid?

SPEAKER_01 5:39

Well, I do know that it cannot include contractors. The question that I don't know the answer to, which Sir Isaac asked me a couple of weeks ago, was would it include independent contractors that are salespeople, for example, for the company?

SPEAKER_02 5:57

What happens to unpaid commissions, bonuses, and contractual agreements between employees and the company?

SPEAKER_03 6:05

I think, Neil, that that that question needs to be addressed in kind of two parts. The first part is with respect to prepetition bonuses and commissions, typically those just give rise to a general unsecured claim against the bankruptcy estate. With the issue of contractual arrangements, that's a little more nuanced. Depending on the specific terms of the contract, you know, that contract might be what we call an executory contract in bankruptcy, which essentially just means that both parties to the contract owe each other continuing obligations. So in the situation of your question where we might have a contract with an employee, if the debtor rejects the contract, then you know they simply get a prepetition general and secure claim that might be paid out at pennies on the dollar. However, if the the debtor determines to assume the contract, meaning they want to continue performing under the contract post-bankruptcy, part of the requirements to assume that contract would require the debtor to cure any defaults under that contract, which would effectively mean that that employee with the contract would be paid in full.

SPEAKER_01 7:27

So that is really the roadmap for whether it's a 30 days or 60 days or whatever, it's a very detailed list of expenses, which once the court authorizes the use of cash collateral, the debtor has the authorization and approval to pay those expenses. And by the way, if it's not on that budget, if it's material, the debtor cannot pay it.

SPEAKER_02 7:58

What is an essential creditor and what would make a vendor essential?

SPEAKER_03 8:04

As a general rule in bankruptcy, you know, a company is not allowed to pay pre-petition debts owing to its vendors. However, debtors in bankruptcy have have created this concept of a quote unquote critical vendor, someone who's so critical to their operations that is irreplaceable, whether due to your location, there's just not a lot of options that provide the same services or do the same thing, or because it's you know only this one entity can can perform it for whatever reason. And debtors in bankruptcy can file a motion requesting permission to pay these critical vendors on that basis. Those motions are semi-disfavored in bankruptcy, but at the same time, they're often granted.

SPEAKER_02 8:47

What happens to the owner's compensation and perks?

SPEAKER_03 8:52

That's a good question as well, Neil. You know, if the owner is a working employee that gets paid a salary like other employees, they they would still be entitled to receive that salary on a post-petition basis. However, things like equity distributions go out the windows. Typically, many of the rights and privileges that an owner has prior to bankruptcy are then subordinated to the rights of its creditors because of kind of the priority scheme set forth in the bankruptcy code where secured creditors are paid before unsecured creditors and everyone's paid before equity.

SPEAKER_02 9:24

How about family members? Have either of you had experiences about maybe an excess amount of family members on the books?

SPEAKER_03 9:33

The case in the Southern District of New York that I referenced earlier, it was a family-owned business. The principal was, I guess, the matriarch of the family, but they also had there were family members on the payroll. And as part of filing, a debtor is also required to file what's called a statement of financial affairs. And one of the things that you have to disclose on the statement of financial affairs is payments to insiders within the last year prior to the bankruptcy filing. And so those payments to insiders are going to be carefully scrutinized by the United States Trustee, by the Unsecured Creditors Committee, if there is one appointed, and by your creditor constituencies, because payments to insiders, such as family members within the year before bankruptcy, are subject to clawback, you know, if they're improper.

SPEAKER_01 10:19

If the family members are working and earning whatever it is they've received in that year, then that's okay. But if they were not working and they were just getting a doll out, those would be recoverable as uh what's called a fraudulent conveyance.

SPEAKER_02 10:37

What is an MOR monthly operating report? And what does the company report on that?

SPEAKER_03 10:45

An MOR is, like you said, it's a monthly operating report, and it's a report that the debtors are required to file on a monthly basis detailing the past month's performance. It includes things like the debtor's monthly revenue, operating income, net income, any payments to insiders, payments to attorneys or financial advisors, as well as your total disbursements. The point of a monthly operating report is to give the court and all parties an interest kind of an ongoing snapshot as to how the debtor's business is faring during the course of the bankruptcy case.

SPEAKER_00 11:20

Do you have a question about bankruptcy? Why not ask the experts? Emails for Neil and Steve can be found in the show notes below. And remember, the first call is always free. Call Neil at 940-808-9451 and Steve at 973-286-6713. You can also find more resources on our websites. Go to corporatebankcy a to z dot com or elementarybusiness.com. You can also find links to those in the show notes down below. Corporate Bankruptcy A to Z podcast and YouTube channel are produced by me, Sir Isaac Smith. Be sure you subscribe and share the episode, and we will see you next time.