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What to do Before You Hear About Their Bankruptcy Filing.
By Len Spagnolo*
There’s no shortage of clever debtors—people who stiff their creditors and shirk their obligations under contracts and other agreements. Some do it out of financial desperation. Others do it to gain a competitive advantage. And some do it just for sport. The most pernicious debtors accomplish their objectives, legally, with the help of an experienced bankruptcy attorney.
Clever debtors permeate the business world. They’re your customers, clients, vendors, borrowers, guarantors, lessees, lessors, warehouses, employers, employees, contractors, subcontractors, owners, materialmen, critical suppliers, airlines, shippers, carriers, health clubs, hospitals, warranty companies, franchisors, franchisees, consultants, consignees, bailees and, yes, even attorneys and accountants. No doubt you’ve encountered one, or will encounter at least one, at some point in your life.
How can you protect your business once the debtor has filed for bankruptcy? The short answer is that you probably can’t. Once the bankruptcy case has been filed, your rights and remedies will be substantially fixed. That’s because the bankruptcy laws generally prohibit creditors from improving their position vis a vis the debtor and other creditors after the bankruptcy filing date. So if you haven’t planned ahead for the debtor’s possible bankruptcy filing, the fate of your claim, and the claims of other creditors, will hinge for the most part on a body of decidedly pro-debtor bankruptcy laws.
In the bankruptcy case, you’ll hold a claim against the debtor. If you’re very fortunate, you’ll receive pennies on the dollar for your claim. If you’re unfortunate, you won’t receive anything. And if it just isn’t your day, the bankruptcy court may order you to return any and all payments you received from the debtor during the 90 days prior to the bankruptcy filing date (so called “preferential payments”). What? Return money to the debtor when he still owes you money? Unfortunately, yes. That’s just one of several vagaries under the bankruptcy laws.
If you want to maximize the recovery of your claim, minimize your risk of having to return any preference-period payments and otherwise shore up your rights and remedies under contracts, leases and other agreements, you must start well before your debtor actually files for bankruptcy. Ideally, you’ll do this “pre-bankruptcy planning” with the advice and counsel of a knowledgeable bankruptcy and creditors’ rights attorney. Equally important, you’ll start the ball rolling when you first begin planning your transaction with the debtor.
Your bankruptcy and creditors’ rights attorney should first inquire about the nature of your proposed transaction with the debtor, including the business, economic and other objectives that you want to accomplish. You two should then discuss various ways of structuring the transaction in light of bankruptcy and creditors’ rights laws.
Next, your attorney should review any documentation that you propose to use in the transaction (for example, purchase orders, terms and conditions, contracts, invoices and other agreements). He may suggest revising the language of your existing documents; or he may suggest using different documents altogether. Your attorney may also suggest using additional documents or agreements (such as letters of credit, personal guaranties, joint check agreements, escrow arrangements, mortgages, security agreements or other credit enhancements). Documentation is a critical component in this whole process. The attorneys’ fees you pay for this service is money well spent.
Your attorney should be able to explain the legal reasons for your structure-of-choice, not only to you but to the debtor (and her attorney, if she has one). This is where it’s important to have an attorney who not only knows the law but can also explain it to non-lawyers (and to lawyers who do not practice bankruptcy and creditors’ rights). Your attorney should also explain the consequences, from your perspective, of any counter-proposals that the debtor may make. Don’t be bashful. This is a complicated area of the law, and there are no dumb questions.
Importantly, your attorney should alert you to the consequences of failing to reach an agreement on your terms. Under the press of negotiating for new business, particularly when your own business is slow, a major danger is that you’ll be too accommodating to the views of the other side—just to close a deal. If you’re negotiating a large deal with a potentially bankrupt debtor, this could ruin your business. Here’s where your attorney earns his fee—and your gratitude. He can keep you from ending up with a deal you should have rejected. Listen carefully and keep an open mind during these discussions.
After you reach an agreement with the debtor, your attorney should remain available to counsel and advise you throughout your subsequent dealings with the debtor. If the debtor’s circumstances change for the worse, you’ll need to decide whether to begin a “workout” (a process of negotiating a restructuring of the parties’ original agreement in light of the debtor’s changed circumstances). At that time, you and your attorney should also discuss your other rights and remedies (for example, filing a collection suit vs. forbearance). As your debtor slides into the “zone of insolvency,” you’ll want to keep your attorney informed of material developments as and when they occur. Having a responsive attorney is absolutely critical at this stage. Unreturned phone calls are unforgivable.
If the debtor’s circumstances deteriorate further (to a point where you may be within a 90-day preference period), you and your attorney should discuss options for coddling payments from the debtor. The trick here is to get paid without having to disgorge the payments later (as a preference), if the debtor files for bankruptcy. It’s difficult to do, but it can be done. Knowledge of the preference laws, and their exceptions, is essential.
If, ultimately, the debtor does end up in bankruptcy, your attorney should have the experience and skill to serve you well in the bankruptcy process. Be mindful that, good as they may be, not all state-court collection attorneys are experienced bankruptcy and creditors’ rights attorneys. The rules of the game change dramatically from state court to bankruptcy court. Make sure your attorney knows bankruptcy law and procedure--cold.
You can’t stop your debtor from filing for bankruptcy. You can, however, position yourself to maximize your rights and remedies if a bankruptcy filing should occur. Pre-bankruptcy planning with a knowledgeable bankruptcy and creditors’ rights attorney is one way a creditor can level (or at least re-balance) the playing field.
Even now, your debtor may be planning his next transaction with you; and he may be doing so with the advice and counsel of an experienced, and perhaps clever, bankruptcy and creditors’ rights attorney. Are you doing the same?
*Partner, Bentz Law Firm, P.C. Len has practiced bankruptcy and creditors rights exclusively for 20 years, including a two-year clerkship with a United States Bankruptcy Judge. He has handled over 3,500 such cases in virtually every bankruptcy court in the country.
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