Partnership Reorganization Under Chapter 11
| Publication year | 1983 |
| Pages | 1207 |
1983, August, Pg. 1207. Partnership Reorganization Under Chapter 11
Jeffrey Cohen, Denver, is an associate with the firm of Quiat and Dice.
The Bankruptcy Reform Act of 1978, hereafter referred to as the "Code," made substantial changes and clarifications in reorganization law. This article deals with some of the salient issues which are unique to the rehabilitation of businesses that operate in the form of a general partnership. To illustrate the important concepts under the Code, a small business fact pattern is utilized. Any resemblance of this fact pattern to actual occurrences or real people or entities is purely coincidental. Two general areas are discussed: case administration and the formulation and confirmation of a plan of reorganization.
Within each of the two general areas, the following topics are analyzed: (1) whether or not the individual assets of the general partners are subject to the reorganization proceeding; (2) whether or not guarantees executed by general partners for partnership debts can be enforced; (3) the salient issues in formulating a plan of reorganization; and (4) the effect of, and standard for, confirming a plan of reorganization. A common theme throughout this article is that partnership reorganization under the Code is both practical and an improvement upon pre-Code law.
Sam and Betty are the two partners in Western Trucking ("Western" or "debtor"), a Colorado general partnership engaged in the trucking of construction materials, including dirt, gravel and sand. They began their business in 1970, and it is their primary source of income. In June 1979, Western purchased a tractor and a bottom-dump trailer and financed it through Triangle Financial Services, Inc. ("Triangle"). The financing was structured using one promissory note for the total purchase price of $70,000. Triangle took back security interests in both pieces of equipment. The note was payable monthly and could be accelerated upon default. The last payment is due August 1, 1984.
In September 1980, the debtor purchased another tractor and trailer combination and financed that purchase through QRS Associates, Inc. ("QRS"). This transaction, as the earlier one, was documented by one promissory note in the total amount of $120,000. It was payable in monthly installments, with the last payment due April 1, 1985. All of the installments can be accelerated upon default. QRS also took back security interests in both pieces of equipment. Both promissory notes were guaranteed by Sam and Betty personally. Western continued to make its monthly payments until June 1982. At that time, the slowdown in the construction industry caused by the nationwide recession significantly decreased Western's gross income. On October 25, 1982, under repeated threats of repossession, Western filed a bankruptcy petition pursuant to Chapter 11 of the Code.
On the date the petition was filed, the debtor owed Triangle $74,000 and QRS $85,000. At all relevant times, the two tractors and trailers had been kept in excellent running condition. The fair market value is $90,000 for the tractor and trailer financed by QRS and $80,000 for the tractor and trailer financed by Triangle. As of October 25, 1982, the debtor owed the Internal Revenue Service ("IRS") $15,000. The debtor also had $37,000 in unsecured trade debt, which is distributed among the following six claimholders: Acme Truck Parts ("Acme")---$7,000; Widgit Installation ("Widgit")---$8,000; Motor Carriage Manufacturing ("Motor")---$6,000; Chevron Oil and Gas of Colorado ("Chevron")---$4,000; E-Z Ride, Ltd. ("E-Z")---$4,000; and Colorado Kenworth ("Kenworth")---$8,000. As soon as QRS and Triangle were informed of the bankruptcy petition, they brought suit against Sam and Betty individually in state court. Trial in that action is set for April 19, 1984.
On February 14, 1983, after extensive negotiations with most of Western's creditors, Western proposed a plan of reorganization. The essence of the plan is to pay claims out of the ongoing operations of the debtor. This is to be done in conjunction with lowering the interest rates on all debt instruments, extending the original maturity dates and paying unsecured creditors less than 100 cents on the dollar.
Specifically, payment of the taxes is to take place in seventy-two monthly installments over six years at 16 percent interest for the full amount of the tax claims. Payment of each secured claim is to be 100 percent of the secured claim in sixty equal monthly installments at 10 percent interest. The unsecured trade debt is to be repaid 70 percent of their allowed claims in sixty monthly installments over five years with no interest. The partners are to retain their partnership interests and make contributions to the plan by limiting their draws to $22,000 per year.
In April 1983, the debtor's plan was submitted to creditors for a vote. The IRS, QRS and Triangle, and both partners voted in favor of the plan; however, five of the six unsecured claim-holders voted against the plan. Thus, the debtor requested a cram-down hearing.(fn1)
On October 25, 1982, the date that Western filed its bankruptcy petition, a new business was created.(fn2) Western
Trucking, a Colorado general partnership, became Western Trucking, debtor-in-possession. The post-petition business operates with all its pre-petition assets but with no pre-petition liabilities.(fn3) After filing, Western's goal is to generate enough cash flow to keep post-petition debt current and to determine what would be available to fund a plan of reorganization. The plan is the bridge between the debtor's troubled past and its reorganized future. The period of time after the petition is filed, but before a plan is confirmed is referred to as the time the case is administered.
Case administration imposes certain procedural requirements upon Sam and Betty.(fn4) They must close Western's old checking account and open a new one under the name "Western Trucking, debtor-in-possession"; and they must make regular financial reports to the United States Trustee by the fifteenth day of each calendar month. These reports must include an income statement and balance sheet for the preceding month and state whether salaries, taxes and insurance are current. The reports are completed under penalty of perjury.
Two substantive issues emerge here. First, would the personal assets of Sam and Betty become part of the bankruptcy proceeding? Second, could QRS and Triangle short-circuit the reorganization process by enforcing their guarantees?(fn5) From the discussion below, it is clear that the personal assets of Sam and Betty would not be part of Western's bankruptcy estate and that QRS and Triangle would be enjoined from enforcing their guarantees.
Under pre-Code law, "a partnership may be adjudged a bankruptcy either separately or jointly, with one or more or all of its general partners."(fn6) The inference drawn from this is that only pre-petition partnership property would be assets of the post-petition debtor, assuming that the individual partners did not join in the partnership petition. However, this position was overruled by the Supreme Court in Frances v. McNeal,(fn7) in which a Bankruptcy Court decree was affirmed that ordered that the individual estate of a partner be turned over to the trustee of the bankrupt partnership. The language the court used was broad:
... the notion that the firm is an entity distinct from its members has grown in popularity, and [this] notion has been confirmed by recent speculations as to the nature of corporations and the oneness of any somewhat combined group. . . . We should infer . . . that the assumption of the Bankruptcy Act was that the partnership and individual estates both were to be administered.(fn8)
Thus, under pre-Code law, the entity theory of a partnership was not fully entrenched and the personal assets of Sam and Betty could be subject to orders of the Bankruptcy Court.(fn9) This could include a prohibition on transferring or further encumbering those assets so that they would...
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