Tips for Dealing with Bankruptcies Caused by the Covid-19 Shutdown

In this excerpt from their “10 tips guide”, Mark Silverschotz, Luma Al-Shibib and Dennis Nolan of Anderson Kill offer a few thoughts on achieving protection from bankruptcies brought on by the COVID-19 pandemic.

Bankruptcies happen. They happen in booming economies as well as in recessionary ones, and they likely will massively occur in the frozen business environment caused by the Covid-19 pandemic. The suddenness of the pandemic’s onset is unprecedented. For many, consequently, dealing with those bankruptcies will be an unwanted and unanticipated new experience. Nevertheless, corporate and individual creditors of those prospective – or already-filed – debtors will want to do what they can, when they can, to protect their interests and minimize the damage to their own operations.

This article, excerpted from a longer “10 tips guide [link to be provided],” offers simple tips to help achieve those protections. “Your mileage may vary”, as the saying goes, but it remains important to buckle your seatbelt.

  1. Review your contracts and credit terms.

When a customer enters a Chapter 11 bankruptcy, the automatic bankruptcy stay prevents creditors from commencing or continuing any efforts to collect a debt that relates to the period prior to the bankruptcy filing date. That means that a creditor cannot sue, cannot write demand letters, and cannot verbally demand payment of “pre-petition” accounts receivable. That does not, however, mean that one should do nothing.

First, a creditor would be well advised to collect and preserve all documents relevant to their business relationship with the debtor. These will include contracts, delivery confirmations, bills of lading, credit agreements, and anything else that provides the factual and legal basis for claims against the debtor. Proofs of claim (the formal documents establishing creditors’ rights to payment through the bankruptcy process) must provide adequate detail to prove one’s claim, and it is never too soon to assemble that support.

Second, because in Chapter 11 a “debtor-in-possession” typically will continue to operate following the commencement of its bankruptcy case, creditors must decide whether they wish to continue to do business with a debtor subsequent to the filing. Often debtors will reach out to suppliers to secure specific post-petition credit terms, sometimes with the assistance of the creditors committee. That said, each creditor must make their own assessment of the post-petition creditworthiness of the debtor. Many Chapter 11 cases are unsuccessful and “convert” to liquidations under Chapter 7, often leaving those who supplied the debtor post-petition burned twice.

Third, irrespective of whether you are going to do post-petition business with the debtor, file your “proof of claim” in order to avoid being barred from your rightful recovery from the debtor’s bankruptcy estate.

  1. Payments to creditors made within 90 days of the bankruptcy should be protected from clawback as preferential transfers if those payments are made in the ordinary course of business.

One of the most frustrating experiences businesses confront is when they are sued for the recovery of a “voidable preference” by a company which they have supplied, which likely still owes money for goods or services delivered but unpaid, and where little to no recovery is to be obtained on account of their resulting claim. “Preferences” concern (in most basic terms) the right of the debtor (or trustee) to recover payments made to a creditor during the 90-day period prior to the commencement of a bankruptcy case, provided that certain criteria are met and in the absence of bankruptcy-specific defenses.

A preferential transfer is one made of the debtor’s property (usually money) on account of an “antecedent debt” (think of a payment of a past-due bill), to or “for the benefit of” the creditor (look in the mirror), while the debtor was insolvent (a legal “rebuttable presumption” during the 90-day period before the bankruptcy case commenced), that gave that creditor more than they would have received had the debtor been liquidated on that petition date (a virtually guaranteed fact). The two most viable defenses to a lawsuit seeking to recover a preference will be that the payment was “in the ordinary course of business” (either between the parties or otherwise within the relevant “industry”) (often expensive to prove), or that the creditor gave “new value” to the debtor (basically meaning you are unpaid for new goods and services delivered following the date you received the preference, subject to certain limitations not relevant here).

The idea behind the preference statute is to bring back those payments “into” the bankruptcy estate and redistribute them to all creditors on a pro rata basis. One that returns a preferential payment, by statute, is given a general unsecured claim for the amount returned. The means of achieving “fairness” is not universally viewed as actually fair, either in theory or in practice, but it is the way the statute works.

If one is dealing pre-bankruptcy with a customer in financial distress, any change in credit terms may deprive a future preference defendant of the “ordinary course of business” defense. Further, if “pressure” is brought to bear on the customer, and late payment thereafter is made, such payments similarly may be deemed “outside” the ordinary course. Some suppliers of a company in trouble will begin to require pre-payment for goods, or request payment of current invoices under standard terms and forego the payment of seriously past-due invoices in order to maintain “regularity” of payment during the period leading up to a bankruptcy filing. These techniques may deprive a plaintiff of being able to successfully assert that the payment they seek to recover is actually on account of an “antecedent debt.”

  1. In a Chapter 11 case, a supplier of goods may qualify for priority payment status above other unsecured creditors under Section 503(b)(9) of the Bankruptcy Code:

Bankruptcy Code Section 503(b)(9) allows trade creditors who have supplied goods to the debtor, in the ordinary course of business, within 20 days before debtor’s bankruptcy filing, to assert an “administrative expense” claim for the value of those goods. In this way, 503(b)(9) provides “priority” status to such suppliers of goods over other unsecured creditors, thereby increasing these creditors’ chances to recover the full payment of their claims.

Although priority status under 503(b)(9) is afforded only to trade creditors that supply goods, some courts have extended 503(b)(9)’s priority status to creditors in mixed claim cases, i.e., those that involve both goods and services. The law on this issue is not uniform, however, and it is important to know the applicable law in your particular jurisdiction if your claim involves such mixed transactions.

While granting priority status to suppliers of goods, 503(b)(9) does not require the immediate payment of allowed 503(b)(9) claims. Bankruptcy courts have discretion in determining whether a vendor is “critical” so as to require immediate payment. This determination is based on various factors, including the prejudice to the debtor, the hardship to the creditor, and the potential hardship to other creditors.

A creditor with a potential 503(b)(9) claim must pay close attention to the bar date notice and any applicable local rules in the jurisdiction where the bankruptcy case is proceeding to determine the procedures for asserting a timely 503(b)(9) claim.

Find the full version of this article here.

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