How To Brace for the Expected Wave of Business Bankruptcy Filings

With the increased expected wave of new bankruptcy filings in light of the coronavirus pandemic, the creditors' rights and bankruptcy practice group at Tripp Scott has some suggestions as to how our clients and friends can take steps to curtail losses when dealing with entities that may file or do file for bankruptcy protection. 

ANALYZE ALL EXISTING CONTRACTS AND AGREEMENTS 

Under the Bankruptcy Code, if a business entity seeks Chapter 11 reorganization protection, it may assume or reject any executory contract. An executory contract is one where there is still performance to be accomplished by all parties to the agreement, such as a lease, employment agreement, distribution agreement, franchise agreement and the like. Additionally, an entity in Chapter 11 can also not only assume an executory contract, but also it can assign the executory contract to a third party, even where there is a prohibition against transfer or assignment in the agreement. If an executory contract is rejected at any time before the confirmation of a Chapter 11 plan, in most instances the rejection dates back to the date of the initial Chapter 11 filing. Pre-bankruptcy claims under a rejected agreement are only paid on a pro rata basis, and post-bankruptcy claims are subject to the availability of cash for payment. Now is the time for all counter parties to executory contracts to review them to see if steps need to be taken in order to add additional protections or to limit exposure in the event of a bankruptcy filing by a counterparty. Landlords need to be especially vigilant as to what rights and remedies may be available to them in the event of a tenant seeking bankruptcy court protection. Our practice group can provide an analysis of the executory contracts in order to give assistance to help to minimize any loss in the event of a bankruptcy filing.

CREATE PROCEDURES TO LIMIT EXPOSURE TO BANKRUPTCY PREFERENCE CLAW BACK CLAIMS

When a person or entity seeks bankruptcy protection either in liquidation under Chapter 7 or reorganization under Chapter 11, a trustee or a debtor-in-possession can seek to claw back payments made to creditors within 90 days prior to the filing of the bankruptcy proceeding. Since there are strict rules as to what constitutes an avoidable preference, credit grantors can take steps prior to a bankruptcy filing in order to eliminate or curtail potential recoveries in the event of a bankruptcy filing. If as a credit grantor you are selling goods or services to a business experiencing financial difficulties, consider applying payments to the most recent invoices as opposed to applying them to oldest invoices. Of course, if it is possible to use payments of invoices as prepayments for future orders instead of applying the payments to outstanding debt that, too, can help to avoid claw back recoveries. It is important that payments received on outstanding debt be consistent, and payments received as a result of aggressive collection activities can open the door for preference avoidance. It is also very important that each credit grantor analyze and review current practices and procedures for dealing with financially distressed customers. The Tripp Scott practice group can assist with not only the analysis, but also in implementing procedures to create impediments to a subsequent call back recovery.

AVOID CONSIGNMENT SALES

As a result of changes in the Uniform Commercial Code which governs secured transactions throughout the United States, the traditional concept of consignments or reservation of title by a seller is no longer valid. Unless specific steps are taken to create a purchase money security interest and to separately identify goods that are sold subject to the purchase money security interest, the vendor will lose any interest in the so-called consigned goods and will be treated as an unsecured creditor in the event of a bankruptcy filing.

UNDERSTAND RECLAMATION RIGHTS

For those clients and friends who sell goods on credit, the Bankruptcy Code provides certain remedies in the event of a purchaser's filing for bankruptcy protection subsequent to the delivery of goods. Under certain circumstances, and providing that the sold goods remain in the possession of the purchaser, a vendor can seek to reclaim goods from a bankrupt purchaser where the goods were delivered within 45 days prior to the bankruptcy filing. Alternatively, the vendor can seek to have an administrative priority claim, which can lead to a 100% payment, for goods delivered within 20 days of the bankruptcy filing. There are very strict rules with respect to notice requirements and the mechanics of reclamation claims, but if properly used, these are valuable tools to mitigate against bankruptcy filing losses. 

BEWARE OF THE AUTOMATIC STAY   

Once a bankruptcy proceeding is filed, a provision known as the automatic stay becomes immediately effective in order to preclude and enjoin any creditor from taking any action to seek to collect a debt or to enforce rights as to property of the individual or entity that seeks bankruptcy court protection. There are very severe penalties that can be imposed for violating the automatic stay, so it is important to understand its scope and breath, and to take steps to make sure that there is compliance. For instance, all billing of past due invoices must be suspended, and all collection activity must be immediately stopped, including any litigation that was initiated before and was still pending when the bankruptcy case was filed. Additionally, secured creditors, landlords and lessors may not exercise any rights or remedies without bankruptcy court approval. There are steps that can be taken by creditors to recover assets, property or insurance proceeds, but relief needs to be obtained to do so from the bankruptcy court. 

KNOW WHEN TO FILE A PROOF OF CLAIM AND WHEN NOT TO DO SO 

Many creditors upon receiving a notice that a debtor has filed for bankruptcy protection will automatically and immediately file a proof of claim. Because there are strategic issues and advantages with respect to potential claw back recoveries to not filing a proof of claim, careful analysis of the benefits of either filing or not filing a proof of claim should be analyzed before taking any action. In Chapter 11 cases, sometimes it is not necessary to file a proof of claim if the creditor's obligation is accurately reflected on the bankruptcy schedules. Filing a proof of claim submits the creditor to the jurisdiction of the bankruptcy court, and this should be avoided when there is the possibility of a substantial potential preference call back action.