The Business Advisor
August 1, 2009
News of CIT’s financial troubles has loomed large in financial reporting of late. The U.S. Government’s refusal to provide further financial assistance to CIT only added to the struggling company’s woes, fuelling talk of an imminent bankruptcy filing. $3 billion in rescue financing that CIT obtained from its bondholders has at least delayed a bankruptcy filing. However, the financing and a related debt tender offer (which may or may not succeed) may not ultimately prevent a bankruptcy filing. The interest rate is 10% over LIBOR and the financing matures in 2.5 years, making a further restructuring of CIT’s debt almost a certainty. The uncertainty surrounding CIT’s future–together with the general weakness of the economy–may also lead CIT’s customers to draw down on credit lines. Additionally, absent an undeniable–and fairly rapid–turnaround it its own fortunes, CIT may lose significant portions of its factoring business, as well as market share in the factoring business, to competitors like Rosenthal & Rosenthal, Millberg Factors and Sterling Bancorp. Perhaps with that risk in mind, CIT has dedicated $1 billion of its $3 billion rescue financing to CIT Trade Financing, its factoring unit. A factor like CIT Trade Financing finances manufacturers by purchasing their receivables and collecting on the underlying invoices to the manufacturer’s retailers and other purchasers of their products.
Like those by Chrysler and GM filings, a bankruptcy filing by one or more CIT entities would be unprecedented. For example, it does not appear that a company which is in the business of factoring has ever sought relief under the current Bankruptcy Code. A CIT bankruptcy filing would also raise at several issues of significant interest to parties doing business with CIT (or another factoring business) as well as other financial service providers who may be affected by such a filing.
The first issue arising in a CIT bankruptcy case could be CIT’s eligibility for bankruptcy relief. “Banks” are expressly ineligible to be debtors under the Bankruptcy Code, and much of what CIT does resembles banking. However, CIT’s eligibility to be a debtor in bankruptcy appears to be a foregone conclusion. Moreover, absent a finding that CIT receives general deposits like a bank and is subject to the type of comprehensive regulation under non-bankruptcy law to which banks are subject, a challenge to CIT’s eligibility for bankruptcy relief would not succeed. Nevertheless, a creditor or other party-in-interest in a CIT bankruptcy might launch such a challenge for strategic reasons.
The second issue is the ability of a CIT debtor to reject its factoring contracts. Chapter 11 debtors-in-possession are given a relatively free hand in rejecting executory contracts. To do so, the debtor need only demonstrate that the contract is burdensome to the bankruptcy estate. That burden is easily met, because decisions to reject are protected by the business judgment rule with its deference to the business decisions of a debtor. The ability of CIT as a debtor-in-possession to reject contracts will be of particular concern to counter-parties to CIT’s factoring agreements, whether they be standard factoring agreements or agreements like non-notification factoring agreements that resemble credit insurance. Clearly, in the current economic climate, the rejection of a factoring agreement will have an adverse impact upon the non-CIT counter-party.
Four recent “mega-cases” reflect various scenarios under which CIT could address its contracts. In both the Chrysler and GM bankruptcy cases, the debtors addressed (and, in fact, were required to address) their contracts on an expedited basis in connection with the sale of their businesses. In Chrysler, where the reorganization lasted only forty-two (42) days (from petition date to the closing of the sale of Old Chrysler’s assets), the debtors quickly assumed–and cured existing defaults under–most of their contracts in connection with the assignment of those contracts to New Chrysler. This procedure clearly facilitated Chrysler’s prompt exit from bankruptcy. Although its Chapter 11 case proceeded quite rapidly, the contract assumption/ rejection process was not quite as efficiently engineered and seamless in GM–perhaps reflecting a pre-petition hope-against-hope at GM that a bankruptcy filing could be avoided. However, New GM has been using the assumption and rejection process as a lever to begin the renegotiation of its contracts to reflect its smaller size. In a more traditional reorganization, which has been pending for approximately eighteen (18) months, the Quebecor debtors employed a commonly used procedure and addressed the assumption and assignment of contracts as part of the confirmation process, assuming or rejecting relatively few of their contracts prior to confirmation. The assumption and rejection process in Quebecor has proceeded quite smoothly. However, there has been some attempt to be creative in negotiating the “prompt” cure of defaults. Finally, in contrast to the Chrysler, GM and Quebecor debtors, the Lyondell and Basell debtors have used the threat of contract rejections to renegotiate their contracts.
At this point, the scenario that CIT would follow with respect to the rejection or assumption of contracts cannot be predicted. However, counter-parties to factoring contracts with CIT can learn from the manner by which other large debtors have dealt with their contracts and should be prepared to address a renegotiation of those contracts with either CIT (or its potential assignee) or to find a replacement source of financing if such renegotiation is not successful. Regardless of how CIT decides to deal with its executory contracts, counter-parties to such contracts would be wise to consult counsel about those contracts now–even before a CIT bankruptcy filing. Although executory contract cure negotiations in recent cases, including Chrysler, GM and Quebecor, primarily involved business people, with the ostensible advantage of reducing legal fees, counter-parties should be aware that negotiating their contractual rights in this way will necessarily increase the danger of prejudice to those contractual rights, given the interplay and complexities of bankruptcy and non-bankruptcy law that come into play. At the very least, it is recommended that counsel be involved in reviewing any cure-related stipulations or agreements proposed by a future CIT debtor.
The third issue that could be raised in a CIT bankruptcy is the vulnerability to avoidance as preferential transfers of CIT’s pre-petition purchases of accounts receivable under its factoring agreements made during the ninety (90) days immediately preceding a CIT bankruptcy filing. Because they are not payments on account of antecedent debt, neither loans by CIT nor its payment of the purchase price for accounts receivable should trigger the preference statute. It behooves the sellers of accounts receivable under non-notification factoring agreements (or similar agreements that resemble credit insurance), however, to ensure that CIT’s payment for an account is contemporaneous with the actual assignment of the account to CIT. In any event, even were a payment by CIT to purchase an account receivable to otherwise constitute a preferential transfer, it would likely be exempt from avoidance as having been made in the ordinary course of business, although it bears noting that the “ordinary course” analysis is very fact specific.
Avoidance of pre-petition payments for accounts receivable by CIT may also arise under the fraudulent conveyance provision of the Bankruptcy Code, which covers payments made during the two years immediately preceding. If an account receivable acquired by CIT proves uncollectible (which could easily be the case for accounts purchased under a non-notification agreement), CIT (or, more likely, a liquidating trustee) would have every incentive to argue that CIT did not receive fair and adequate consideration in exchange for the price it paid for the account, thereby rendering the payment avoidable as a fraudulent transfer. However, because CIT would have determined that the purchase of an account or accounts receivable constituted an acceptable credit risk, absent fraud or a misrepresentation on the part of the seller, CIT (or a trustee in a CIT bankruptcy) would not likely succeed on such an argument.
The fourth issue a CIT bankruptcy would raise is the whether, and to what extent, either a liquidation of or failed reorganization attempt by CIT could have a domino effect upon certain industries by its adverse impact upon numerous similarly situated small-to-medium-sized businesses of the type that CIT has traditionally funded. In the current credit situation, alternative financing sources will be difficult, if not impossible, to find for the reported 1 million or so businesses that CIT has been financing, although regional banks may be stepping into the breach. It is, perhaps, fortunate that CIT has reduced its financing to such businesses in the last year, thereby forcing some of them at least to begin looking elsewhere for financing. Nevertheless, given the current financial climate, the loss of a significant source of credit will surely adversely affect many of the small-to-medium-sized businesses currently financed by CIT, as well as the companies with which they, in turn, do a significant amount of their business.
Finally, what form would a CIT’s bankruptcy take? In contrast to Chrysler or GM, there will not likely be an entity set up to purchase CIT’s business at a sale under § 363 of the Bankruptcy Code. However, it is widely recognized that, unless CIT has a firm plan on how to reorganize its business, bankruptcy is not likely to help, especially if the case languishes for any period of time. Media reports indicate that, if CIT files for bankruptcy, its best chance of surviving would be to enter bankruptcy with either a pre-packaged plan and sufficient creditor support or a pre-arranged plan that has substantial creditor support so that CIT is not negotiating pre-petition with all creditor constituencies. In any event, as with GM and Chrysler, the sooner a CIT debtor emerges from any bankruptcy case it might file, the better for that debtor, its creditors and its customers. Delay will almost certainly decrease the chance of a successful reorganization.
If you have questions or need further information on the foregoing issues, please contact David Crapo or another member of the Financial Restructuring and Creditors’ Rights Department.