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Last Updated: Sunday, 16 October 2005, 15:38 GMT 16:38 UK
Q&A: New US bankruptcy protection laws
Changes to US Chapter 11 bankruptcy protection laws came into effect on Monday 17 October. BBC News looks at what the new system involves and how it will affect companies.

Legal papers
Filing for Chapter 11 will now be a little harder for firms

Why change the rules?

Essentially, there are two reasons.

On the one hand, US policy makers feel the old system has been abused by several large corporations in recent years, so they are keen to make it both more costly and more laborious for companies to go into Chapter 11.

On the other hand, the change is seen as a dig by Congress at a perceived tendency by bankruptcy lawyers to respond favourably to requests from troubled companies, for example by allowing their management teams more time to sort things out.

What's so wrong about letting the bosses fix the companies they're in charge of?

There have been instances where company directors have chosen the Chapter 11 option as a strategic measure to get some breathing space while they restructure their corporations, only to use the law as a means of forcing workers to accept job cuts, pay cuts and reduced pension rights and to force creditors, including suppliers, to write off debts.

Under the new rule, companies are given 18 months to put forward their restructuring plans, which should specify how company directors aim to rise out of the red and get back in the black.

This is longer than the current three months time limit, but the old deadline was artificial since judges often allowed lengthy, sometimes indefinite, extensions. The new deadline is meant to be inflexible, and it also opens up for competing restructuring plans to be put forward by outsiders.

But by then the directors will have already given themselves serious fat-cat bonuses, so why should they care?

True, in the past it has been galling for creditors and employees to see how restructuring programs have been pushed through at their expense, only for the directors to cash in big bonuses and lucrative stock options.

But the practice of giving bonuses to so-called key workers - read senior executives and other favoured members of staff - to reward them for sticking with it through difficult times is coming to an end.

Bankruptcy lawyers can still accept such bonuses being awarded, but no longer as a matter of routine.

Only when it can be proved that there are lucrative offers from other companies on the table will the courts allow troubled companies to award retention bonuses or option packages.

So the new rules should help the little guys?

Well, it is not quite that simple, but at least suppliers who unwittingly keep delivering to companies on the brink are reasonably well protected under the new rules.

Under the new rules, firms delivering goods to a troubled company during the 20 days before it files for Chapter 11 will be first in the queue of creditors, whereas under the outgoing rules they would have to line up behind secured lenders.

This means they would generally be quite likely to get paid, whereas in the past they would generally end up with little or nothing.

Telephone bills, water bills and electricity bills are also more likely to be paid under the new rules since companies filing for bankruptcy protection under the new Chapter 11 rules will have to put up actual payment guarantees for two months into the future.

In general, under the old system a troubled firm would merely be asked to prove it had enough cash to pay such bills at the outset of the period, though come payment day there would be no guarantee the cash was still there.

Other third parties, such as owners of properties rented by troubled companies, should also benefit from the changes. In the past, landlords were often strung along by companies refusing to say whether or not they would renew or cancel leases. The new rules introduce less flexible deadlines.

Good news for peripheral creditors, but not so good for professionals offering secured loans. Surely this will make it harder for firms to borrow money?

Certainly, this should make it harder for troubled firms to land deals with major financiers before they file for Chapter 11 bankruptcy protection.

In the past, there have been instances where companies have negotiated deals that secure them finance that will tie them over during restructuring periods, in return offering a place at the front of the queue of creditors.

Such deals will not be easily achieved in the future.

How has corporate America responded to the changes?

Some corporations have hurried up and filed for Chapter 11 bankruptcy protection to ensure they can restructure under the old rules.

Some industry watchers say evidence that some firms have behaved this way can be found by looking at the number of new filings during the last two or three months.

Apparently, there were about 10% more filings than there were during the same period a year ago, though this could also have something to do with the general economic climate.

Well, that may be a problem in the short term, but in the long-term this should all be fine then?

Well, there is widespread agreement that the old system had to be changed, but the new rules create problems of their own.

Take the way it has become harder to offer retention bonuses. Critics say such deals offer vital incentives for executives to go ahead with painful but necessary decisions needed to salvage companies before it is to late.

Such actions may be avoided in the future, leaving companies to soldier on until there is nothing left to rescue.

Moreover, failure to offer staff with key skills incentives to stay throughout a period of restructuring could result in many of them leaving, thus making the restructuring efforts more difficult.

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