Frequently Asked Questions

How do companies who file chapter 11 “get rid of their debt” post-bankruptcy if they couldn’t do it pre-bankruptcy? What exactly happens when a company “gets rid of debt” without paying? Is that just when the court absolves it?

     Under the Bankruptcy Code, the confirmation of the reorganization plan discharges (that is, cancels) all pre-bankruptcy debt. The debt that remains is the new (replacement) debt provided for in the plan.
     When an individual debtor files chapter 7 bankruptcy, the trustee sells all of the debtor’s “non-exempt” property (usually nothing) and distributes the proceeds to creditors. The debtor’s remaining debt is discharged, that is, cancelled. When an individual debtor files chapter 13 bankruptcy, he or she must make monthly payments to creditors, under a chapter 13 plan, for a specified period. If the debtor completes the plan, any remaining debt is discharged.
     In chapter 11, the process is more complicated, but the result is the same. The debtor files a plan of reorganization that explains how it will treat its debt (that is, how much, when, and how creditors will be paid). Sometimes, the plan provides that all creditors will be paid in full. But in most cases, chapter 11 plans provide for only partial payment on some debt. The debt provided for in the plan replaces the pre-bankruptcy debt, and any remaining, unpaid debt is discharged.

How long is a company in chapter 11?

It’s impossible to say. The Pacific Lumber Company (Palco) chapter 11 cases could last as long as two years, or longer, but they could be over much sooner.
A company stays in chapter 11 until one of three things occurs: the bankruptcy court confirms the company’s plan of reorganization; the court converts the case to a chapter 7 (liquidation) case; or the court dismisses the case. In the Palco cases, the last two are possible but not likely. Most likely, the Palco companies will stay in chapter 11 until a plan is confirmed.
A plan of reorganization is a document that explains how the company will treat its debt (that is, how much, when, and how creditors will be paid). If the company’s ownership will change, the plan will state who the new owners will be. The plan (and related documents) will also include a post- bankruptcy business plan for the company and identify post-bankruptcy management.
Under the federal Bankruptcy Code, only the debtor (here, Palco) can propose a reorganization plan during the first 180 days of the case. This period is called the “exclusivity period.” During the exclusivity period, because other parties (like the noteholders’ or creditors’ committees) may not propose a plan, the debtor has an advantage in the negotiations. The court may extend the exclusivity period, but only to a maximum of 18 months. The court may also shorten or terminate the exclusivity period.
It’s impossible to predict how long the Palco cases will last. But Palco will probably try to propose a plan during the exclusivity period, because if it fails to do so, it may fear that it will lose control of the process. Once a plan is proposed, the confirmation process typically takes less than six months. Accordingly, it’s likely that these chapter 11 cases will not last longer than two years, although it could be significantly longer or shorter.

What happens if a company cannot pay post chapter 11 payments? How can it continue to function?

If a company cannot pay its post-bankruptcy expenses, the court would probably convert its case to a chapter 7 liquidation case. This is unlikely to occur with Palco. A company that commences a chapter 11 bankruptcy case is temporarily relieved of the obligation to pay pre-bankruptcy debts. But it must pay all post-bankruptcy (“administrative”) expenses, such as current wages and salaries, payments to vendors for post-petition deliveries and services, rent, taxes, etc. A company that cannot pay its administrative expenses is called “administratively insolvent.” The Bankruptcy Code requires that a company must pay administrative expenses in full to confirm a plan of reorganization and emerge from chapter 11. Because an administratively insolvent company cannot do so, the court would likely convert its case to a chapter 7 liquidation case. In chapter 7, the court appoints a trustee, who sells (or “liquidates”) the company’s assets and distributes the proceeds to creditors. The Palco companies’ main pre-bankruptcy obligations were the semi-annual interest payments on the Scotia Pacific (“ScoPac”) notes – $27 million, due every February and August. We understand that Palco can operate profitably and pay post-bankruptcy expenses if it doesn’t have to pay this interest. If so, the case’s conversion to chapter 7 is unlikely.

Answers to Your Questions

Could the noteholders’ motion to have the property of Scotia Pacific (“ScoPac”) declared to be “single asset real estate” affect the timing?

Absolutely.
ScoPac is a subsidiary of Palco created to hold most of Palco’s timberland, which is the collateral for the $714 million in debt held by the noteholders.
The Bankruptcy Code’s definition of “single asset real estate” is complex. In short, it means real estate consisting of a single property or project that generates substantially all of the debtor’s gross income. If the bankruptcy court agrees that ScoPac’s property is a single-asset-real-estate property, then ScoPac must, within 30 days, either propose a plan of reorganization that has a reasonable possibility of being confirmed in a reasonable time or begin making interest payments to the noteholders. If ScoPac fails to propose a plan or begin interest payments, the noteholders could foreclose on their collateral (ScoPac’s timberland).
The noteholders’ motion contains many uncertainties. No court has ever applied the single-asset-real-estate provisions to timberland, and it’s not clear if this court would do so. And it’s not clear, if the court did, how much interest ScoPac would have to pay. But since the Palco companies originally commenced their chapter 11 cases to avoid paying interest to the noteholders, a ruling in favor of the noteholders on their motion would probably accelerate the resolution of these cases.
The court will hold a hearing on the noteholders’ motion in March.

The noteholders’ committee, the state agencies, the federal agencies, the creditors’ committee, and the United States Trustee have all asked the bankruptcy court to move the case from Corpus Christi to California. Why would some local vendors ask to keep it in Texas court?

Beats me.
We should assume that Palco didn’t make any payments or promises to the local vendors to get them to support Palco’s request that the case stay in Texas. That’s because it would be a felony for Palco to make such a promise or payment, under section 152 of title 18 of the United States Code.
Seriously, some of these vendors may genuinely believe that Palco is more likely to survive in its present form, with present management, if the case is handled as far away as possible from California.

Why is it important to determine the timberland’s value?

The value of the Palco assets – principally ScoPac’s 220 acres of timberland – may determine who controls Palco when the case concludes. If the assets are worth more than the debt, Maxxam and Hurwitz may retain control. If the assets are worth less than the debt, the noteholders may gain control. A chapter 11 case ends when the bankruptcy court confirms a plan of reorganization. Under the Bankruptcy Code, the plan must pay creditors’ claims in full before shareholders may retain their interest in the company. This is called the “absolute priority” rule – by law, creditors’ claims have absolute priority over shareholders’ interests. The Palco cases are like many other large corporate bankruptcies – where an otherwise healthy business is burdened by excessive debt to noteholders, and the company’s value is less than the amount of the notes. Those cases often end with a plan of reorganization that includes a “debt-for equity” swap. In a debt-for-equity swap, a portion of the debt is paid in stock. That is, under the plan the noteholders receive new notes for a portion of their claim and new company stock for the rest of their claim. Frequently, the new stock issued to noteholders will be 100% of the company’s stock. The old stockholders’ stock will be canceled, or “wiped out.” They receive nothing. So – if the timberland’s value is greater than the claims, Maxxam and Hurwitz may be able to propose a plan that pays creditors in full and allows them to retain control. If the timberland’s value is less than the claims, the plan may include a “debt-for-equity” swap, in which the noteholders receive some new notes and new company stock for part of their claims, and Maxxam and Hurwitz’s interest in the companies is reduced or eliminated. In documents filed with the bankruptcy petitions, Maxxam and Hurwitz stated that the companies’ assets had a value of more than $900 million. We understand that many people in the community, including foresters and other analysts, have valued ScoPac’s timberland at less –substantially less than the $714 million in bond debt. Because it may determine who controls the company post-bankruptcy, the value issue may be a critical issue in the case.

How will the timberland’s value be determined?

If the parties don’t agree, the court will decide. If Palco’s asset was a used car, the value would be easier to determine – check the Blue Book. If it was an apartment building, realtors could testify as to the sale prices of comparable properties. But ScoPac’s timberland will be more difficult to value. Different valuation methods might be used, but the most likely method would be to estimate the future revenue that the timberland could produce over a period of years, and then to calculate the present value of that future revenue stream. These calculations involve several uncertainties. To estimate future revenue from the timberland, you have to predict, over a period of years, how many trees Palco will be permitted to log and the prices that it will get for the lumber. To give a present value to that revenue stream, financial experts apply a “discount rate,” which is based, in part, on a prediction of future economic conditions, such as inflation rate, etc. Many people in the community believe that Palco bases its high valuation of the timberland on an unrealistic future logging rate – a rate that is not possible in light of both the timberland’s condition and environmental and regulatory concerns. But good faith estimates of the timberland’s present value can vary widely, because of the many uncertainties in the calculation – including future logging rates and prices and the applicable discount rate. In cases like this, where valuation is critical and subject to uncertainties, it’s not uncommon for the parties to settle. For example, the old shareholder might agree that creditors should receive 95% of the new stock in the company, and the creditors allow the old shareholder to retain a 5% interest. It’s cheaper, quicker, and more certain for the parties to settle than to fight the issue to the bitter end, even if, under the “absolute priority” rule, the old shareholder’s interest might be wiped out.

If there is no settlement, who decides the property’s value?

Both sides – the debtor and the creditors – hire financial experts and consultants. They conduct detailed analyses, give their conflicting opinions in court, and explain all the factors used to reach their opinions. It’s a long and expensive litigation. In the end, the judge decides.  He may agree in full with one side or another, or he may pick a value in between.

If there is a debt-for-equity swap, will the management change? Will there be new local management?

Probably. When a plan of reorganization is filed, other documents filed at the same time must include a future business plan and list the members of the post-bankruptcy board of directors. If the plan includes a debt-for-equity swap, under which noteholders gain control of the company, the new board would include a majority of noteholder representatives. Because the company’s debt would be reduced, the business plan would probably reflect a reduced logging rate. The new board will likely appoint management – including local management – to implement its new business plan. At this time, it’s too early to speculate on the nature of that business plan or who the new board members and company managers might be.