Thursday, April 12, 2018

If a Customer Files for Bankruptcy - Follow This Checklist

By Steve Stapleton

The Bankruptcy Code offers a variety of protections to trade creditors when a customer files for bankruptcy.  While not intended to be a comprehensive guide, the following offers an outline of those things you should think about and what steps you might want to consider when faced with a customer filing bankruptcy.

Monitor the Bankruptcy Case

File an Entry of Appearance to ensure receipt of the pleadings filed in the case.  Determine whether the debtor has filed under chapter 11, in which the business continues under the debtor’s management while the debtor attempts to restructure its debt -- or chapter 7, in which a trustee is appointed and the debtor’s assets are liquidated.  Obtain copies of the salient pleadings and review them carefully.  Attend the meeting of creditors which can afford you an opportunity to examine the debtor under oath with regard to its intentions generally and as to its obligations to you specifically.

Review the Underlying Documents

If a lease or contract informs your relationship with the debtor, make sure those liable for the debt have filed for bankruptcy protection or identify whether they may be related to or affiliated with the bankrupt entity.  Determine, too, as mentioned below, if the payments under the contract or lease may constitute cash collateral. Determine a methodology for ensuring payments on a post-petition basis, whether a cash deposit, letter of credit or payment on a COD basis.

Ensure a Cash Collateral Order is in Place

Postpetition goods are entitled to priority as an administrative claim, but you must determine whether the payments the debtor makes to you constitute cash collateral (that is, collateral consisting of cash and equivalents, bank accounts, etc.) subject to liens on such collateral or a blanket lien on all the debtor’s assets.  If the payments do constitute cash collateral, make sure you have the secured creditor’s consent to the payment.  Ensure that such consent continues during the bankruptcy by reviewing the cash collateral order (and amendments thereto) and the debtor’s proposed budget of operations.

Stop the Delivery of Goods in Transit

Stop the delivery of goods that have not yet shipped (Uniform Commercial Code [UCC] §§2-702(1) and 2-703) unless title has already transferred at the time of shipment, the debtor pays cash, or the goods are in the hands of a third-party carrier or warehouse (UCC §705).  Once stopped, reship COD or return the goods to the warehouse.  As stated above, ensure there is a cash collateral order in place before cash payments are made.  If the debtor already possesses the goods, exercise state law-based reclamation rights within 10 days of debtor’s receipt (UCC 2-702(2)).

Watch Out for the Automatic Stay

Once a debtor files for bankruptcy protection, the automatic stay comes into effect and any action taken to collect on your debt is prohibited.  Any action in violation of the stay taken without court authority is void or voidable and such action taken with knowledge of the bankruptcy proceedings may invoke punitive damages.  Separate the debtor’s prepetition obligations from its postpetition obligations.  Without court approval, the debtor is prohibited from paying its prepetition obligations and creditors are prohibited from collecting them.  Postpetition, the debtor is generally obligated to pay for the value of the goods and services delivered.  File a motion to terminate the stay if there is a rationale for continuing with whatever litigation was initiated prepetition.  With court authorization, exercise contractual set-off and termination rights.

Assert Your Reclamation Rights

Make a reclamation demand to recover your goods within 45 days of the debtor’s receipt of goods or 20 days from the petition date if the debtor filed for bankruptcy within 45 days of receipt of the goods.  Determine if there is a reclamation order in place approving reclamation procedures.  As mentioned below, determine if a critical vendor order is in place that authorizes payment to such vendors.  

Assert Administrative Expense Claims

Assert section 503(b)(9) claims (involving the debtor’s receipt of goods within 20 days of bankruptcy if sold by the debtor in the ordinary course) by filing a motion for payment of such  claims.

Perfect Mechanic’s Liens

Statutory liens are available in most jurisdictions that secure payment for services, labor and materials related to any improvement on real property.  Perfect such liens and after perfection, file a notice of perfection under section 546(b)(2).

Seek Critical Vendor Treatment

Many jurisdictions authorize a debtor to pay its critical vendors.  If such authority exists, make sure you’re on the list and if not, be prepared to offer evidence as to why you should be.  Ensure the critical vendor order and agreement does not contain unreasonable trade terms or prohibitions that prevent you from raising your prices during the bankruptcy or that preclude you from suspending the agreement on default.  Try to negotiate a section 547 waiver for payments received by the debtor in the 90 days prepetition, and a section 549 waiver ensuring payments made under the critical vendor order are not clawed back if the order is reversed or the case is converted to chapter 7.  Ensure that the order is not subject to subsequent rejection and does not preclude the pursuit of reclamation claims.

Protect Set-Off and Recoupment Rights

If a debtor has claims against its creditors, the creditors will want to exercise state law-based set-off rights and retain property subject to set-off as defenses to a prospective turnover action or a claim asserted by the debtor.  File a proof of claim asserting your set-off rights.  If the debtor proposes to sell its property, make sure set-off rights are accounted for and protected.

Exercise Your Rights under any Executory Contract

The debtor has the ability to accept or reject its contracts or leases under which performance generally is due on both sides, referred to as executory contracts. If you are subject to any such contracts, you should request that the court set a deadline by which such contracts should be assumed or rejected, or demand adequate protection during the interim period under UCC section 2-609.  You should file an administrative claim for the value of benefits received during such interim periods.  Review the contract to make sure there has been no default and ensure, prior to its acceptance, that the debtor has cured any such default.

File a Proof of Claim

For all obligations of the debtor that occurred before the bar date, prepare and file a Proof of Claim.

Prepare for the Assertion of a Preference Claim

Transfers by an insolvent debtor based on a preexisting debt 90 days before the bankruptcy filing (or 1 year if the creditor is an insider of the debtor) that allow the creditor to receive more than it would have received in a liquidation are subject to recovery by the debtor as preferences.  Be proactive.  Even before preference claims are filed, make sure all the elements to any possible preference are met, review any available defenses, such as payments made in the ordinary course or according to ordinary business terms.  In the unlikely event that the elements of a preference are met and no defenses apply, negotiate a settlement.

Get Involved; Pay Attention

The most critical thing you should bring to the table is vigilance.  Once a bankruptcy petition is filed the case tends to move very fast.  A failure to file a timely objection or a failure to assert your rights in a timely manner may be fatal.

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