Bankruptcy fundamentals: What trade credit professionals need to know

For many credit professionals, bankruptcy can be one of the most stress-inducing business experiences. It is often a costly and lengthy process, testing a company’s financial resilience and the emotional bandwidth of everyone involved. Important deadlines arise quickly, notices are frequently sent by ordinary mail and failure to act on certain notices before deadlines can result in the loss of your company’s rights and claims.

Why it matters: Credit professionals play a critical role in protecting the financial interests of their companies. With the right resources and guidance, they can build practical strategies to minimize risk and maximize recoveries in a customer bankruptcy. Here is what creditors need to know when a customer files.

The Breakdown: A Bankruptcy Overview

Under the Bankruptcy Code, bankruptcy aims to relieve individuals or businesses from overwhelming financial obligations while ensuring creditors receive fair, orderly repayment from available assets. Essentially, the debtor can get a “fresh start” by discharging, restructuring or creating manageable repayment plans for their debts.

One of the most common forms of bankruptcy a creditor encounters is Chapter 11, which allows businesses or other entities to keep operating while they restructure their finances. The debtor remains in “possession,” retaining the powers and duties of a United States Trustee, and with court approval, may borrow new funds. Despite the “reorganization” label of Chapter 11, businesses can use Chapter 11 bankruptcy to reorganize or to sell substantially all of their assets and liquidate. Key players in Chapter 11 bankruptcy include:

• U.S. Trustee: An independent overseer of bankruptcy cases; a division of the United States Department of Justice.
• Creditors’ Committee (appointed by the U.S. Trustee): A group of (typically) three to seven unsecured creditors serving as a fiduciary representing the interests of all unsecured creditors in a debtor’s Chapter 11 case, with its own professionals compensated by the estate.
• DIP Lender: A lender providing post-petition financing to the debtor, typically protected by broad liens covering all or substantially all assets and senior to existing secured lenders.
• Other potential parties: Other secured creditors (pre-petition lender), taxing authorities, trade and other unsecured creditors, the PBGC, landlords or asset purchasers.

A Creditor’s Actions While the Case is Underway

Credit professionals will often receive little notice of events between the start of a case and the debtor’s attempt to exit bankruptcy. “Any notice received during this time may have a direct and material effect on a creditor’s rights and should be reviewed expeditiously, but carefully,” said Michael Papandrea, Esq., partner at Lowenstein Sandler LLP (Roseland, NJ), during an NACM webinar, Bankruptcy 101: A Trade Creditor’s Guide to a Customer’s Filing. “And even where a creditor does not receive direct notice, events during this time—such as a sale of substantially all of the debtor’s assets—can have a significant impact on the eventual return to creditors.”

Creditors with significant exposure should track important developments by having counsel file a notice of appearance or by diligently monitoring the case docket. Large Chapter 11 cases typically have claims and noticing agents that offer email notifications of new filings.

The Automatic Stay: Stop All Actions the Moment You Hear of a Filing

Immediately upon filing, an injunction called the automatic stay is imposed against creditors seeking to start or continue collection actions against a debtor or the debtor’s property. It halts lawsuits, foreclosures, judgment collections, contract terminations, setoffs and any other actions to pursue pre-bankruptcy claims against the debtor or its assets. Violating the automatic stay may result in sanctions against your company. “The moment you receive a bankruptcy notice or even hear about the potential for bankruptcy, stop all collection activity and consult legal counsel,” said Papandrea.

Under Section 362(d) of the Bankruptcy Code, a creditor can resume collection efforts only by obtaining relief from the automatic stay by filing a motion with the court. However, motions for relief from the automatic stay are not frequently granted except in unique circumstances. Creditors should consult bankruptcy counsel if they believe they have a basis to obtain stay relief.

Know Your Claim: Gather and Preserve Information Immediately

Once notified of a bankruptcy, begin preserving all information related to the debtor. “You want to gather those records as soon as possible because you don’t want to risk losing data in the course of the bankruptcy case,” said Papandrea. “This evidence can help you determine your preference liability and potentially guide decisions in the case.”

Examples of the information creditors should gather include credit files, invoices, bills of lading and delivery receipts for goods received by the debtor within 20 days of bankruptcy. Any letters, emails, phone logs and text messages between your company and the debtor are also helpful. Documentation relevant to preference exposure is just as necessary, including payments received within 90 days of the bankruptcy filing, at least two years of payment history for the ordinary course of business defense and invoices or proof of delivery for the new value defense.

Court filings are accessible through the U.S. Public Access to Court Electronic Records (PACER) service for a small fee, or free through a debtor’s claims agent website if one has been retained.

Securing Critical Vendor Status

Unless an agreement is already in place, a creditor is not obligated to continue doing business with a debtor during a bankruptcy. Even where a contract is in place, creditors may have the ability to stop extending credit but should consult with bankruptcy counsel before making the decision to do so.

Where a debtor relies heavily on particular suppliers, it may ask the court to permit the debtor to grant certain creditors “critical vendor” status.

Critical vendor programs authorize a debtor to pay pre-petition claims of creditors deemed critical or essential to the debtor’s ongoing business or reorganization. It must be approved by the court and is a court-created concept with no explicit provision under the Bankruptcy Code. “In the construction industry, we’re often working on multiple job sites with a customer, and because they can’t risk losing our business, we’re appointed as a critical vendor,” said Karen Lando, credit manager at Irex Services LLC (Lancaster, PA).

However, creditors should not just accept a debtor’s proposed critical vendor agreement (often labeled a “Trade Agreement”) at face value as critical vendor orders and agreements frequently include extremely debtor-friendly terms. These agreements should be negotiated with the help of bankruptcy counsel to protect creditors. Similarly, if a Chapter 11 debtor tenders payment on account of a pre-bankruptcy claim, there may be a critical vendor order in place deeming you to accept the debtor-friendly terms of the debtor’s critical vendor program, which may include continuing to extend credit. Consulting with counsel in that circumstance can help avoid traps for the unwary creditor.

Proofs of Claim and Bar Dates: Read Every Notice and Never Miss a Deadline

At some point, a creditor may be required to file a Proof of Claim notifying the court and other parties that a debt is owed. Missing the applicable bar date could eliminate your right to recover anything. If a Proof of Claim is not timely filed, it may still be worth filing a late claim even though allowance may be an uphill battle.

If you can establish that you were not properly notified of the bar date, you may be able to have your claim treated as having been timely filed so long as the estate’s funds have not yet been distributed. “You need to provide a reasonable excuse for having missed the bar date,” said Andrew Behlmann, Esq., partner at Lowenstein Sandler (Roseland, NJ). “Most often, it’s attributed to failure of due process or failure of service, such as the debtor failing to send a notice or the debtor sending the notice to the wrong place.”

Executory Contracts: You Must Keep Performing Until the Debtor Decides

In bankruptcy, a debtor has the power to assume, reject or assign executory contracts, agreements where both the debtor and a third party have material performance obligations remaining. Common examples include supply agreements and consignment contracts. Until the debtor decides, both parties must continue to perform. If a contract is rejected, the creditor is left with the damages claim. If assumed, all pre-petition amounts owed must be cured. Creditors may file a motion to compel the debtor to make an earlier decision, though courts rarely grant this relief. Creditors are encouraged to consult with counsel if before deciding to decline to extend credit or otherwise withhold or condition their continued performance under an executory contract.

The bottom line: When a customer files for bankruptcy, the window to protect your claim and other rights is short and the consequences of inaction are severe. Credit professionals who remain vigilant and proactive can better protect their company long before a filing ever occurs.