REPORT FROM COUNSEL 

SUMMER ISSUE, 2005

REVISIONS TO BANKRUPTCY LAW CREATE DRASTIC CHANGES

By Daniel Y. Gielchinsky, Esq.

On Wednesday, April 20, 2005, President Bush signed into law a long-expected series of legislation that drastically altered this country's bankruptcy laws. In order to fully explain the affect of this new legislation, some background is helpful.

There are three popular forms of bankruptcy relief available. A Chapter 11, which is used by corporate entities, can be thought of as a reorganization of debt. In short, the debt-ridden company can restructure its debt obligations to creditors and equity obligations to its shareholders through the use of a Chapter 11. A company can continue to run and manage its own day-to-day affairs in most cases, and the potential exists for a company in Chapter 11 to emerge from the bankruptcy with a significantly improved financial picture. In some situations, a company's management will continue to run the day-to-day affairs of the company, and the company is then referred to as a debtor-in-possession. Ironically, this leads to circumstances where the same inept management that put the company into its precarious financial situation remains in place during the company's continued management. In other circumstances, a representative from the United States Trustee's Office will be appointed by the Court to oversee the management and day-to-day operations of the company.

A Chapter 13 is a personal form of a Chapter 11. In a Chapter 13, the individual(s) who declared bankruptcy will be devising a plan to pay back their creditors over time. This form of bankruptcy is most often used when the debtors are in arrears on their mortgage for their residence. The advantage of using Chapter 13 in this circumstance is that this form of bankruptcy relief allows the mortgage arrearages to be "crammed down", or paid back to the bank over a period of time. The advantage of this form of bankruptcy is that it allows a distressed homeowner to remain in possession of the residence, and affords the debtor with an opportunity to pay back mortgage arrearages over what typically becomes a five year period. However, the debtor will necessarily be devising a plan to also pay back other creditors, such as banks, credit cards and other forms of debt.

A Chapter 7 bankruptcy can be used by corporate entities or individuals. A Chapter 7 bankruptcy is often referred to as a liquidation, since if the debtor obtains a discharge of its debts, there will be no repayments of the debts in the future. This form of bankruptcy is also most often thought of as a consumer bankruptcy, since it is most often used to discharge credit lines and credit card loans. The recent legislation is targeted directly at these consumer bankruptcies.

The bill that President Bush signed into law was not the first attempt by Congress and the Senate to limit the scope of Chapter 7 relief. The powerful banking lobby has been advocating the change in bankruptcy laws for a number of years. However, a similar bill with other measures attached to it was turned down by the Senate approximately one year ago. The recently passed legislation was strongly opposed by consumer rights groups who argued that it would prevent debt-ridden people from giving the "fresh start" that is envisioned by the bankruptcy laws.

The new law, which takes effect in six months, will have the result of converting what would have been Chapter 7 filings into Chapter 13 repayment plans. People at income levels that are higher than their respective state's median income level will have to pay some or all of their credit bills, medical bills and other obligations through a court-ordered bankruptcy plan. The new legislation encompasses a complicated formula that will be utilized to determine the type of bankruptcy relief an individual will be able to avail himself or herself. In summary, those people with discretionary incomes of $100 a month or more will be forced to use that income to repay their debts over a five-year period. It is estimated that between 30,000 and 210,000 people, representing approximately 4%-20% of those who discharge their debts through bankruptcy each year, will be disqualified from doing so under the new law.

Ironically, the legislation comes at a time when it seems to be least needed. New personal bankruptcy filings went from 1,613,097 in the year ending June 30, 2003 to 1,599,986 in the year ending last June 30, which runs counter to the upward trend of recent years. Needless to say, the downward trend will continue, although it is expected that there will be a spike in personal bankruptcy filings during the next six months, until the legislation becomes law.

Aside from the drastic effect the new law will have on those who need bankruptcy relief, one area of the legislation that was not well publicized was its impact on bankruptcy practitioners. The new provisions, which have raised major concerns among the bankruptcy bar, will require debtors' attorneys to vouch under oath for the accuracy of their clients' financial statements in a manner that greatly expands what was required under the old law. In the future, lawyers themselves could be held financially liable for their clients' misrepresentations. The net effect of these provisions will be to reduce the amount of bankruptcy practitioners, thus making it more difficult for individuals in need of bankruptcy protection to find a willing attorney to represent them. In so doing, the banking lobby has created another hurdle for individuals whose credit card bills, penalties and interest have gone over their head.

Clearly, the wide availability of a complete discharge of debt through the use of a bankruptcy will be greatly limited by the new legislation. Those who find themselves in a constrained financial situation are well advised to take advantage of the current bankruptcy laws before the new legislation goes into effect. We at Herten Burstein are able to provide a full range of bankruptcy services, including both debtor and creditor representation, bankruptcy litigation, relief from stay applications, and defenses of preferential transfer and/or fraudulent transfer claims.

Daniel Gielchinsky is an associate in our litigation department with extensive bankruptcy experience.

NEWS FROM HERTENBURSTEIN.COM

  • "Diversity and experience" -- those words were chosen by New Jersey Monthly Magazine in its recent edition on Super Lawyers to describe our Firm. Four of our equity members were honored at having been chosen as Super Lawyers by New Jersey Monthly Magazine. Thomas J. Herten, Terry Paul Bottinelli, Arnold D. Litt and Steven B. Harz had an article written about their accomplishments in the special edition on the top attorneys in New Jersey. Needless to say, our Firm is very proud of the recognition they have received.
     
  • We are still growing! Welcome to lawyers Lori L. Bibko, Carolyn B. Hand and Justine A. Zeppone who will be working in our products liability litigation department. The Firm also hired Nicole Stinson who joins our paralegal staff. Assisting our lawyers, are Chris Karounos (Rutgers University School of Law), Michael Saily (New York Law School), Robert E. Spiotti (Wake Forest University School of Law) and Robert Tucker (Ohio State University School of Law) all of whom have been hired as summer law clerks. These additions to our fine staff allow us to continue providing top notch service to our clients.
     
  • As we grow, we are eagerly anticipating the Firm's move into our new offices. Construction is progressing at a rapid rate. Presently our expected occupancy date is targeted for early July. The additional 7,000 square feet and redesign will allow for a more efficient operation of our office facilities.
     
  • Speaking about expansion, Arnold and Elaine Litt announced the arrival of two new grandchildren. Daughter Jody and son-in-law Dan are the proud parents of twin girls, Carly and Alexa, whose birth instantly doubled the number of Litt grandchildren (all girls). With three daughters and four granddaughters, Arnold's minority shareholder status within the family remains secure.
     
  • Congratulations to Andy Cevasco's daughter, Alison who graduated from the University of Scranton and will be working for the Jesuit Voluntary Corp. in California. Steven Harz's son, Jonathan is also a member of the class of '05 and is a graduate of Vanderbilt University. He will be pursuing a career in government.
     
  • Our Director of Operations, Dave Polizzotto recently attended the American Legal Administrators National Conference. The event took place in San Francisco. Dave, who was chosen as a proctor, returned with several suggestions as to how to continue to improve the administration of our Firm.
     
  • After a five day trial, Thomas J. Herten recently obtained a successful verdict involving a dispute between members of a limited liability company. The matter was tried in New Jersey Superior Court -- Chancery Division and involved the testimony of forensic accounting experts. The Court's decision established the parameters upon which the business would be valued and resulted in a highly favorable buy-out figure to the Firm's client. Tom was assisted in the trial by associate Daniel Gielchinsky, who somehow still found time to write an article in this edition of the newsletter on the new revisions to the bankruptcy law.
     
  • The Open Public Records Act ("OPRA") is a fairly recent law which requires that governmental bodies make available their public records. Unfortunately OPRA provides very little guidance as to what is a public record. If the wrong decision is made and a document is not released as a public record, then the governmental entity would be subject to fines and payment of legal costs incurred to obtain the public record. These were the issues facing associate Craig Bossong of our Firm who had to counsel one of our municipal clients regarding an OPRA request for copies of fire and burglar alarm permits. Craig successfully argued before the Government Records Council who agreed with his opinion that these documents are not public records citing safety concerns and the reasonable expectation of privacy.
     
  • The New Jersey Business and Industry Association ("NJBIA") annually recognizes the best and most exciting real estate development projects in the State of New Jersey. The Firm would like to congratulate its client Mercedes-Benz USA, LLC on having its regional distribution center, recently constructed in Washington Township, Mercer County, recognized by the NJBIA for this prestigious award. Tom Herten, Manny Toskos, Susan Marra and Nilufer DeScherer formed the Firm's team who provided legal assistance to MBUSA, LLC on this complex project.
     
  • This spring about 200 public officials, including members of governing bodies, planning boards and zoning boards, took part in the annual Bergen County Bar Association Land Use Symposium. The event was located at Bergen Community College and consisted of several workshops where public officials were able to attend lectures presented by volunteer attorneys and other professionals. The program was organized by Manny Toskos, a Co-Chair of the Bar Association Land Use Committee who moderated a panel consisting of Judge Harris, Judge Contillo and Judge Donohue of the New Jersey Superior Court. Jason Shafron, Nilufer DeScherer and Craig Bossong were among the attorneys who presented lectures. This event is the Bar Association's largest community legal education program of the year.
     
  • From our products liability group, attorney Stephen Sugrue, who is also a trained nurse, provided a three part training course in cardiopulmonary resuscitation. The course was given in-house and available to all our employees. Those who took the course are now certified by the American Heart Association. The Firm is grateful to Steve for his efforts. Now if we only find a dietician to help us prevent the heart attack.

BUSINESS STARTUP--SHOULD YOU BE A "FRANCHISE PLAYER"?

Launching a business is a little like walking a tightrope, with any long-term rewards coming only after overcoming some risk. Being well-informed and realistic from the outset is essential. One of the first considerations is the legal form that the business should take. An option that has the potential for achieving a good balance between risk and reward is the franchise.

A franchise is a relationship between the owner of a trademark or trade name (franchisor) and an individual or entity (franchisee) who contracts to use that legally protected identification in a business. The details of the relationship are controlled by a franchise agreement, but most franchises share some common characteristics. Typically, the franchisee sells goods or services that are either supplied by the franchisor or at least must meet standards set by the franchisor. In simple terms, the franchisor provides the ingredients that come from the proven experience of an established line of businesses, while the franchisee provides the elbow grease and all of the other intangibles that are needed if a fledgling business is to get off the ground and prosper.

There are two types of franchises. The simpler version, known as a "product/trade name franchise," is the sale of the right to use a business name or trademark. In the more complex form, called a "business format franchise," the fates of the parties are tied together more closely and for a longer period of time. In this format, the franchisee trades some of its independence in exchange for various forms of assistance from the franchisor.

Money Matters

One benefit of a franchise is that the prospects for a healthy bottom line are enhanced, since the risks of the investment are reduced by being associated with an established company and its good name. But that boost is not without cost. A would-be franchisee should always be aware of the financial commitment involved, but not be too quickly scared away by the reality that here, as in most business matters, "you have to spend money to make money."

It is only prudent to consider carefully a number of likely expenses. There is the initial franchise fee, sometimes nonrefundable and usually at least a few thousand dollars. Costs to rent or build an outlet and to purchase the initial inventory will be significant. The full range of expenses depends on the type of business, but some of the other typical expenses include fees for licenses and insurance, ongoing royalty payments to the franchisor based on income and for the right to use the franchisor's name, and payments into the franchisor's advertising fund.

Who's in Charge Here?

It is the nature of a franchise that, in exchange for getting to hitch its wagon to the franchisor, the franchisee agrees to give up some of the control over how the business will operate. There still should be room for putting a personal stamp on the business, but the franchise business model is not for someone who would have difficulty giving up the decision-making power that comes with starting a business. Owners of a "Mom and Pop" do not need permission for their store's color schemes, but the franchisee probably will.

As set out in the franchise agreement, the franchisor will usually have the final say about the specific goods and services that may be sold, site approval for the business location, design or appearance standards, as well as authority over an array of operational matters such as hours of operation, signs, employee uniforms, and even bookkeeping procedures. On the larger scale, the franchisor also may limit the franchisee's business to a specific territory.

Parting Company

A franchisee's breach of the franchise agreement, such as by failure to make payments or to comply with performance standards, could result in termination of the franchise and loss of the franchisee's investment. Even without a breach, a franchisee must foresee that franchise agreements generally run for a finite period, such as 15 or 20 years. Of course, if both sides so desire, the agreement can be renewed under the same terms or perhaps even terms more favorable to the now-proven franchise. But the franchisor could decide not to renew, and it usually reserves the right to do so for its own reasons. If there is a renewal, the parties must agree again to all of the terms and conditions. The franchisor may take that opportunity to make changes in the deal to its benefit. In that event, the franchisee would be wise to give a fresh look at whether owning a franchise still makes business sense.

Anyone seriously considering buying and running a franchise needs to do the homework first, and the Federal Government has made that process more organized. The Federal Trade Commission (www.ftc.gov) requires franchisors to prepare a disclosure document, sometimes called a Franchise Offering Circular, that puts in one place a wealth of information about the franchisor, current and former franchisees, and what the franchisee is agreeing to when the franchise agreement is signed. Reading and understanding the disclosure document, not to mention the franchise agreement itself, is essential. One should always seek independent professional advice before making a commitment to a franchise arrangement.

NEW TAX DEPOSIT RULES FOR SMALL BUSINESSES

As of January 1, 2005, the IRS increased the minimum threshold for Federal Unemployment Tax Act (FUTA) deposits. Under the previous rule, employers were required to make a quarterly deposit for unemployment taxes if the accumulated tax exceeded $100. Now the threshold is $500.

The IRS estimates that this change will lighten the load for more than 4 million small businesses. Assuming an employer makes timely state unemployment tax payments, the most that the IRS will collect from employers per employee is $56 per year. Before the threshold was increased, most employers with two or more employees had to make at least one federal tax deposit a year. Now employers with eight employees or fewer will be freed from the requirement of making as many as four FUTA deposits per year