Update on the 2005 Bankruptcy Act: it's a boon to creditors and a bane to debtors.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 will spur significant changes that will have an impact on Detroit-area businesses, particularly the automotive industry.

Its provisions are, for the most part, beneficial to creditors of companies that have sought bankruptcy protection. The Act significantly expands the dollar amount of administrative claims, which must be paid either during the case or at the time the debtor confirms its plan of reorganization. This increase will allow suppliers to receive numerous benefits not previously available, including:

* Treating amounts owed to suppliers of goods delivered in the ordinary course of business during the 20 days prior to filing the Chapter 11 petition as administrative claims.

* Significantly expanding the right of a supplier to make reclamation demands for inventory delivered 45 days prior to the bankruptcy filing.

* Increasing the administrative claims for wages and benefits owed for services performed prior to the petition date from $4,925 to $10,000 per employee.

* Requiring the debtor to provide cash security deposits to utilities

These benefits to creditors will place a substantial, and in some cases, a crushing burden on the debtor company. For example, in a just-in-time inventory environment common in the auto supply industry, the cost of goods for the 20 days prior to a bankruptcy filing can be enormous.

Many provisions of the Bankruptcy Code are subject to the discretion of the bankruptcy judge. Several sections of the Act have placed limitations on that discretion. For example, a debtor must now assume or reject nonresidential real property leases no more than 210 days from the date of the debtor's filing Chapter 11. The debtor has a maximum of 18 months to have the exclusive right to file a plan of reorganization. Both of these matters previously had no outside deadline.

The Act also greatly limits the amount of severance and other benefits that can be paid to directors and officers during the Chapter 11, and expands the ability of creditors to recapture unreasonable payments made to directors or officers during the two years preceding a filing. These provisions may make it more difficult for companies in financial trouble to attract and retain highly competent managers.

The Act benefits those sued for preferences by creating a defense to a preference claim if the claim is for less than $5,000, and requiring claims for less than $10,000 to be brought in the state of residence of the defendant rather the home court of the debtor. Finally, the Act limits the preference defendant's burden with regard to proving it dealt with the debtor in the ordinary course of business. Formerly, a defendant had to prove that alleged preference payments were both in the ordinary course of dealing with the debtor AND that such dealing was in accordance with industry standards. Under the new law, the defendant only has to prove one of the two standards to have a good defense.

The Bankruptcy Act contains numerous other provisions affecting cases, requiring customers, suppliers, lenders, debtors, landlords and others to rethink strategies that have previously been routinely employed in bankruptcy cases. The legislation is complex, and new questions on interpretation and application of the law are likely to result in significant litigation in Detroit over the next several years.

Ronald L. Rose is a member at Dykema Gossett PLLC, a Silver-level member of the Detroit Regional Chamber. He is also the co-leader of the firm's Bankruptcy Practice Group and a fellow of the American College of Bankruptcy.

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