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The vast majority of suppliers, vendors, lessors and lenders have experienced the difficult task of navigating a bankruptcy case. Certain customers file for bankruptcy due to a significant drop in business that impairs their ability to pay their debts as they come due; others may file to stave off aggressive collection actions. Whatever the cause, the commencement of a bankruptcy case sets in motion a process designed to afford financial relief to the debtor while ensuring that its creditors have an opportunity to receive fair treatment. Creditors must understand and take certain critical steps in the bankruptcy to guarantee the best possible treatment of their claims.
1. Recognize the Red Flags.
One of the most important steps for any creditor to take actually arises before the debtor files for bankruptcy. Creditors must recognize the red flags that often telegraph a bankruptcy filing. These red flags include the debtor missing payments when due, seeking to renegotiate payment terms, or explaining that payments will resume once business returns to normal. The debtor may also refuse to discuss the payment of past due invoices or fail to return calls from its creditors. Finally, collection lawsuits or other legal actions taken by creditors may be the most apparent indicator of an impending bankruptcy. A creditor that recognizes these precursors can anticipate a bankruptcy file and take the preliminary steps necessary to maximize its recovery.
2. Who, What, Where, When, Why.
Once you find out that a client has filed for bankruptcy, take note of every detail provided in the initial notices, such as the date the debtor filed and the bankruptcy court where the case is pending. These details are important, as they trigger various deadlines to which creditors must adhere if they wish to preserve their rights. For example, if a supplier wishes to assert reclamation rights, it must send a proper notice to the debtor within 20 days of the filing date. The filing date also sets the 20-day, pre-bankruptcy period that may entitle a creditor to full payment for goods delivered to the debtor during that 20-day period. The initial filing (called the voluntary petition) may also identify key information about the debtor, such as its address, attorneys, estimated assets and liabilities, and its 20 largest creditors. Creditors should understand this information and be aware of the issues that quickly arise following the initial filing.
3. Understand Your Claim.
The type of claim that a creditor has almost always dictates the treatment it will receive. Secured creditors will often receive either the value of their collateral or will receive relief from stay to repossess and liquidate their collateral. To that end, secured creditors must understand their loan documents and recognize issues that often arise, such as whether they perfected their security interests in the debtor’s collateral, whether they have priority in a specific piece of collateral, and whether the debtor can adequately protect their interests in the collateral. Answering these questions will impact the treatment received through the bankruptcy.
Unsecured creditors, such as vendors and suppliers of goods and equipment lessors, must likewise understand their claims and how the Bankruptcy Code will treat their claims. Since unsecured creditors are almost last in payment priority, they often receive pennies on the dollar for their unsecured claims. To maximize their recovery, unsecured creditors must understand which portions of their claims may earn higher administrative priority. As noted above, creditors are entitled to be paid in full for goods delivered to the debtor within 20 days of the bankruptcy filing. Bankruptcy court often require these creditors to file a motion seeking approval and payment of this type of administrative claim.
Additionally, if a debtor relies primarily on the good will of its vendors and suppliers to continue doing business, the debtor may need to seek bankruptcy court approval to pay its “critical” vendors the value of their pre-petition claim to ensure that they continue to do business with the debtor. As for lessors, the bankruptcy code imposes deadlines on the debtor to assume or reject unexpired leases. If the debtor assumes the lease, it must cure all defaults under the lease and provide adequate assurance of future performance before it can assume the lease. These topics barely scratch the surface of all of the various rights and protections for secured and unsecured creditors, which is why all creditors must completely understand their claims from the start.
4. Be Wary of Key Bankruptcy Protections.
Creditors must also be aware of key protections that the Bankruptcy Code affords to debtors after filing for bankruptcy – specifically, the automatic stay. The Bankruptcy Code automatically imposes a stay, subject to certain exceptions, of all actions by a creditor to collect against a debtor for a pre-petition debt. One of the most common mistakes a creditor makes immediately after a debtor files for bankruptcy is it violates the automatic stay. These violations occur in a variety of ways, such as: i) discontinuing utility services on account of an unpaid, pre-petition date; ii) attempting to enforce or collect on a pre-petition judgment; iii) demanding payment for a pre-petition debt; and iv) seizing property that belongs to the debtor’s estate.
If a creditor knowingly violates the automatic stay, the bankruptcy court may impose damages, including sanctions, for the violation. To avoid the risks associated with violating the automatic stay, if a creditor believes it has grounds to pursue claims against the debtor, the best course of action is to move for relief from the automatic stay. As with administrative expense claims, bankruptcy courts require a motion setting forth the grounds for seeking relief from stay, which it can only grant after notice to the debtor and a hearing.
5. Pay Attention: It’s Not Junk Mail.
One of the most critical mistakes many creditors make at the outset of a bankruptcy case is to disregard important notices from the bankruptcy court, the debtor, and other creditors. Creditors that receive the initial notice of a debtor’s bankruptcy filing will likely receive hundreds, maybe thousands, of notices throughout bankruptcy case. Creditors must review these notices, as many include important deadlines that could potentially bar any recovery at all. For example, bankruptcy court sends out a Notice of the Section 341 Meeting of Creditors, which sets a time and place for creditors to ask the debtor questions about the bankruptcy. Not only does this notice set the 341 Meeting, it often sets a bar date for filing proofs of claim and for commencing actions to determine the dischargeability of debt. Missing either of these deadlines could significant impact a creditor’s ability to recover against the debtor.
Many other notices are equally important and may impair the rights of creditors if disregarded, such as motions to authorize use of cash collateral and approve debtor-in-possession financing. There is simply no way to overstate the importance of reviewing notices received about a bankruptcy case. Failing to do so may result in an unassailable bar to recovering against the debtor.