Affected by a Bankruptcy Filing? 5 Things In-House Counsel Should Know

By Rachael Smiley, Attorney/Shareholder

With bankruptcy filings increasing, and many economists continuing to predict a recession in the next 12 to 18 months, the likelihood that your organization will be affected by a filing is on the rise. Below are five issues to be aware of when a customer, tenant or other party connected to your organization files for bankruptcy so that you can ensure that your rights and interests are protected.

Proofs of Claim:  Although it is not required to file a proof of claim in a chapter 11 case if the debtor has correctly scheduled your claim, it is a best practice to do so, especially since the scheduled amount of a claim is rarely accurate, and a proof of claim filed by a creditor is considered prima facie valid and entitled to allowance unless and until the debtor objects to it. Claims must be filed by the “bar date” which is often set within the first 60 days of the case in complex chapter 11 matters.  It is important to provide your bankruptcy counsel with the documents supporting your claim in advance of the bar date. Late claims are rarely paid, absent a court order, and are typically subject to objection.

Preferences: A “preferential” payment occurs when the debtor makes a payment on account of an antecedent debt within the 90 days prior to filing a bankruptcy petition. The debtor or trustee then holds a cause of action to recover the payment for the benefit of the creditor body as a whole (the policy being that certain creditors should not be “preferred” to others by receiving payments on the eve of a bankruptcy case and should return their payments to make the playing field more level for all creditors).   Preferences are frustrating for creditors because they can be liable without having done anything other than rightfully collect payment that they are entitled to. Preference liability cannot be entirely avoided; however, there are steps you can take to reduce exposure:

  • If you are worried that a customer might be insolvent or planning to file for bankruptcy in the near term, and you are concerned about accepting potentially preferential payments from this customer, it is wise to go ahead and accept the payment anyway. Although you might ultimately receive a demand for the return of the payment, a settlement can typically be negotiated with the debtor or trustee that will permit you to retain some of the payment.  By contrast, if you do not accept the payment, you have a very small likelihood of ever receiving much in return for an unsecured claim from the bankruptcy estate. 
  • Avoid stepping up your collections efforts with a customer you perceive to be insolvent or potentially filing for bankruptcy. Stick to your ordinary pattern of communications with these customers, and make sure employees in your A/R department are aware that they should not deviate from ordinary communications or collection efforts. Putting pressure on a prospective debtor to pay sooner or in larger quantities than they would ordinarily pay can invalidate certain defenses you may have to a preference claim.   

Automatic Stay:  The filing of a bankruptcy petition imposes an automatic injunction or “stay” against, among other acts, “any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case.”[1]   It is a violation of the stay to make any efforts to collect any debts that arose prior the petition date. Make sure your A/R department has a system in place for identifying customers who are in bankruptcy, and that employees are aware they should make no collection efforts with respect to prepetition debts for these customers.

Administrative Claims:  Has your organization continued to provide goods or services to the debtor after it filed for bankruptcy?  Or are you a counterparty to a lease with the debtor?  You are entitled to be paid 100% of these expenses (or otherwise whatever amount you agree upon with the debtor) as an admirative claim following plan confirmation if such expenses have not already been paid in the ordinary course of business during the bankruptcy case. Most chapter 11 cases also have specific administrative bar dates (in addition to the regular bar date) for asserting administrative claims. Let your bankruptcy counsel know if you have been providing post-petition goods or services and think you may have an administrative claim. 

Asset Sales:  Has a competitor or other player in your industry filed for bankruptcy? Chances are they may be selling some or all of their assets.  The Bankruptcy Code provides for a debtor or a trustee in a bankruptcy case to sell assets free and clear of liens, claims and encumbrances pursuant to an expedited process. Because you will be receiving a “free and clear” order from the Bankruptcy Court, there is essentially little or no risk of successor liability, and due diligence costs are significantly reduced.  If you already hold a security interest in the debtor’s assets, you can credit bid the value of your collateral at a sale; likewise, the sale of the assets to another party will result in your liens attaching to the proceeds of the sale. 

 Familiarity with these issues can help you and your team stay on top of a bankruptcy filing, get bankruptcy counsel the information they need, and best protect your organization.  Getting in touch with your outside bankruptcy counsel as soon as you learn of a filing is key.

[1] See 11 U.S.C. § 362(a).  Other acts that are prohibited by the automatic stay include commencing a lawsuit against a debtor, enforcing a judgment against it, or any act to create, enforce or perfect a lien against the debtor’s assets.