Expert explains Freedom Industries bankruptcy case

Jan. 30--CHARLESTON, W.VA.--Although the Freedom Industries case has put bankruptcy court in the spotlight, some may not know what is involved in the process.

Like civil and criminal processes, bankruptcy court has its own set of intricacies. Two bankruptcy attorneys explained the different types of bankruptcies and what is involved in Freedom's case.

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Scott Stapleton, with the Huntington-based Stapleton Law Offices, said the three most common types of bankruptcies are Chapters 7, 13 and 11.

Freedom Industries filed for Chapter 11 bankruptcy Jan. 17, following the Jan. 9 leak of crude MCHM into the Elk River.

Stapleton said Chapter 11 cases generally are used for two purposes. A business either can reorganize in an attempt to save itself or as a way to orderly liquidate to prevent a "cannibalization by creditors," the people or companies to which it owes money.

"Chapter 11 prevents a creditor feeding frenzy and the idea is you don't want it to be the (creditor) who is most aggressive," Stapleton said. "It's a logical systematic liquidation."

For the vast majority, Stapleton said, the goal is to reorganize.

"Chapter 11 is well-suited for businesses that have had a one-time, non-recurring big problem," Stapleton explained. "If they can get a problem fixed, they can return to profitability. This is not for businesses that are unprofitable and always will be unprofitable. Those end up converting to Chapter 7."

Chapter 7 is "straight liquidation," and Chapter 13 is not available to limited liability corporations, said Andy Nason, an attorney with the Charleston firm Pepper & Nason.

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What are the chances of reorganization?

Nason said there have been success stories where Chapter 11 businesses have completely turned everything around. Sometimes, however, businesses convert to Chapter 7.

"Freedom's got a real uphill problem even without the lawsuits, but I don't know," Nason said. "They haven't even filed their schedules yet. ... Apparently, they were a successful business before this problem arose. They may be able to reorganize. They may not. It's too early to tell."

Typically, it takes about 240 days after filing the original bankruptcy petition to file a plan of reorganizations, Nason said.

When a business files its reorganization plan, it has to say what happens with the debts and assets, Stapleton said.

"They can't just file and say, 'I don't feel like paying debts.' It has to say, 'here are the assets, debts, income, overhead operating expenses," Stapleton said.

After the company submits a reorganization plan in writing, the creditors are given a chance to object. The court then plans a hearing on the plan and also any objections filed in the case.

If the plan is approved, the court monitors it to make sure the company fulfills its terms and conditions.

Businesses also must list basic information in a disclosure statement such as real property, personal property, secured/unsecured creditors and tax claims, Nason explained. Freedom must file the schedules along with a statement of financial affairs by the end of the month.

Nason said representatives from the debtor and the U.S. Trustee's office will get together in a phone conference to go over the basic information to make sure the company has insurance in place for the property.

Also in Chapter 11 cases, debtors shut down the pre-petition bank account and open a new one referred to as "debtor in possession," Nason explained.

"They want to make sure the debtor in possession is out of the bank account so someone looks at and checks to see what's pre-petition and what's post-petition," Nason said.

Besides a Feb. 11 final hearing on Freedom's financial motion, one of the next big steps is a creditor meeting. The hearing usually takes place 30-45 days after the petition is filed.

Stapleton said in this meeting creditors ask questions of a company's representative under oath. Generally, the representative is the president of the company.

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When a Chapter 11 petition is filed, a bankruptcy stay goes into effect, preventing lawsuits from going forward unless the bankruptcy judge says otherwise.

The bankruptcy judge determines to what extent the stay is lifted. Most of the time, Nason said, litigation proceeds against the insurance companies.

Stapleton said the reason for this stay stems back to preventing the "feeding frenzy."

"You want to deal with debts according to law," Stapleton said. "If you have 42 lawsuits continuing right on to devour, you do not have a chance to reorganize. That's the whole idea behind the bankruptcy stay. All creditors freeze, hold their positions until (the judge) can hear the facts and decide what's fair."

Attorneys also may file lawsuits in the context of the bankruptcy, called adversary proceedings.

"That would be something where you say you believe the type of the debt owed to us in non-dischargeable," Stapleton said.

Since these types of lawsuits are within the bankruptcy, they are not subject to the bankruptcy stay. The bankruptcy judge determines if the case should be in this proceeding.

In Freedom's case, there was an adversary proceeding filed Jan. 20. However, this proceeding was dismissed the day after filing without prejudice, which means it can be re-filed once the bankruptcy judge gives the green light for all lawsuits to move forward.

So far, no other adversary proceedings have been filed in this case.

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Another facet to Freedom's case deals with the lending of the money to the company.

Under the financial agreement, Freedom gets a $3 million cash infusion from Mountaineer Funding with the potential for an extra $1 million later. Attorneys called this type of loan, "insider lending" and said it was rather common in bankruptcy proceedings.

Mountaineer Funding is owned by J. Clifford Forrest, who also owns Chemstream Holdings, Freedom's parent company. Mountaineer Funding was incorporated Friday, the same day Freedom filed for Chapter 11 bankruptcy protection.

The water company argued the terms of Freedom's original financing proposal would give the lending company a lien on Freedom's assets, a "super priority" claim and the ability to foreclose selectively on assets, taking away the most valuable assets from Freedom's estate, "leaving behind only the toxic facilities and huge damage claims caused by the Freedom spill."

However, attorneys said this had been resolved in the resolution reached in a hearing last Tuesday.

"Now, I think the crux of the opposition to this loan may have been not that the loan was made by an insider but that the insider may have received, by virtue of the relationship, special treatment, that a loan made at arms-length transaction, the debtor may not have given up the same things they may have been given up to the insider," Nason explained.

Nason said to put insider lending in perspective, think about borrowing from a bank compared to borrowing from a family member.

"If you went to the bank and wanted to borrow $5,000, you might not be willing to put a just-paid-off car for collateral as a loan," Nason said. "You go to your mom or dad and say you need $5,000, and give a lien against your car. If you don't pay, then they can have your car. You're more willing to do that."

Contact writer Andrea Lannom at [email protected] or 304-348-5148. Follow her at www.twitter.com/AndreaLannom.

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