Particularly in the current economy, it is not uncommon for purchasers, anywhere along the supply-to-distribution chain, to claim financial distress and file for bankruptcy relief. How can a person or entity hope to collect on debts owed by a “bankrupt” purchaser? There follows a basic primer on bankruptcy terms and procedures, as well as steps an unsecured creditor may follow to be in the best position to collect on what is owed without incurring substantial attorneys’ fees.
A company seeking bankruptcy relief by filing a “Petition” is called the “Debtor.” Every person or entity that is owed money by the Debtor, even if the debt is disputed or contingent, is a “Creditor,” and the debt is what is called a “Claim.” Ideally, the petition is mailed or emailed to all Creditors, which is called “serving” the Creditors; but as a practical matter, the Debtor frequently has not prepared its full list of Creditors and therefore serves the 20 largest Creditors and other known Creditors initially and serves later-ascertained Creditors afterwards.
If your company is a Creditor, it is precluded by an “automatic stay” from taking any action to collect the debt, starting or prosecuting a lawsuit, creating or enforcing a lien, or doing just about anything else that might affect “property of the estate,” defined broadly as encompassing any interest that a Debtor might have in property as of the filing of the Petition. If a Creditor unaware of the Petition takes action in violation of the automatic stay, some jurisdictions (including California) consider the action to be void and other jurisdictions hold that it is voidable if the Debtor asks the court to void the action. Worse still, if a Creditor with knowledge, or deemed to have knowledge because of the circumstances, acts in violation of the automatic stay, the Creditor can be hauled before the bankruptcy court and held in contempt, punishable by a fine and, in certain circumstances, incarceration.
What Should You as an Unsecured Creditor Do?
First, retain a bankruptcy lawyer to research some information readily obtainable from the Court’s file (which should take about an hour) to determine
- Is the entity that filed for bankruptcy relief the exact same entity that owes you money or is already the defendant in your lawsuit? If so, you must stop all collection efforts and halt your lawsuit.
- Is the Debtor seeking Chapter 7 relief (always liquidation, always managed by a court official called a Trustee) or seeking Chapter 11 relief (often a sale of the business or an internal reorganization, usually run by the Debtor as a “Debtor in Possession”)?
- Has the Debtor checked the box on the form saying that it estimates that funds will be available for distribution to unsecured creditors? Or has it checked the alternative box?
- Who is proposed legal counsel for the Debtor? The group of lawyers that handle business reorganizations is small, and if your counsel is part of the group, he or she can find out a lot from a phone call.
- Who are the Creditors, and what are the amounts specified, of the Claims that the Debtor considers to be the 20 largest? If your Claim is among the 20 largest, you should talk to your counsel about the pros and cons of becoming a member of the creditors’ committee. (In most Chapter 11 cases, there is appointed an “Official Committee for the Unsecured Creditors,” which retains counsel paid out of the Debtor’s estate to represent the interests of the body of unsecured creditors as a whole.)
Second, unless your Claim is so small as to be immaterial, discuss with your counsel the particular facts surrounding your Claim and unusual actions that you might want undertaken immediately. Taking these actions will entail additional attorneys’ fees, but the amount of fees may be warranted on a cost-benefit basis. For example:
- Did you deliver goods to the Debtor in the 20 days before the Petition was filed? The money that you were not paid for those goods is an “Administrative Claim” that is payable ahead of general unsecured claims. But it will only get Administrative Claim treatment if you know to characterize your claim as an Administrative Claim. In some circumstances you will want your counsel to make a motion for immediate determination of your Administrative Claim (often achievable) and immediate payment of your Administrative Claim (rarely granted).
- Is there a reason that your lawsuit against the Debtor needs to move forward immediately or some piece of the lawsuit must move forward? If so, you will want your counsel to make a motion for relief from the automatic stay to let the lawsuit, or some portion of it, progress.
Third, even if you decide not to engage counsel beyond that initial hour because your claim is routine, you should make sure that someone in your company is responsible for the following activities and can reconsider whether you need counsel if the circumstances warrant it:
- Review all the papers sent by the Court or served by the parties to understand what is happening and whether it is relevant to your Claim.
- Pay particular attention to the “Bar Date” for filing Claims, or simply file a Proof of Claim properly near the start of the case. The Proof of Claim must be completed properly with copies of documents relevant to the Claim attached. Unless you have in-house experience with this, it is worth a call to bankruptcy counsel to discuss how the Proof of Claim should be completed. If a Proof of Claim needs to be amended later, that is allowable so long as it is not a different Claim that is being asserted.
- Be on the lookout for papers that are an objection to your Claim. Often an objection is an omnibus objection to many claims of many creditors, and the designated person must look carefully at every objection to see if it pertains to you, when the deadline is for responding, and when the hearing will be. I know from personal experience as Debtor’s counsel that the Debtor prevails on many objections to Claims because the Creditor’s eyes have glazed over from court papers and they have stopped reading them. If there is an objection to your Claim and you cannot resolve it over the telephone, you will want to have bankruptcy counsel represent you in court.
- Be on the lookout for a “Disclosure Statement” and proposed “Plan of Reorganization.” These are lengthy documents but, somewhere in the middle of the legalese, they say what class unsecured creditors are placed in and what is to be given to that class. Unless you consult bankruptcy counsel, you will not know if the Plan gives unsecured creditors what they are entitled to, but if there is a Creditors’ Committee, its counsel is responsible for getting the maximum to unsecured Creditors consistent with the priorities set forth in the Bankruptcy Code.