This past quarter end once again reminded us that the economy remains weak and borrowers who have managed to hang on for the past three or four years are running out of staying power. The topic again arose - what to do when a borrower files bankruptcy? Faced with the prospect of throwing good money after bad, some lenders bury their head in the sand and simply wait it out, often with terrible results. Others charge ahead aggressively and run up large legal bills that are not justified by the amount of the obligation or the difficulty of recovery.
Over the years, I have encouraged clients facing a bankruptcy filing by a customer to stop and carefully consider the available options. Here is a simple checklist to run through while reaching a decision that will preserves the Bank's rights in a manner that is cost-effective.
- Start with a clear understanding of the facts. Take a few minutes to collect the loan documents, payment history, appraisal, title report, UCC search and other critical information. Make sure you understand the basics about the loan and the relationship between the borrower and the Bank.
- Talk to the relationship officer. Find out whether there were warning signs or special problems that affected the borrower's ability to repay the loan or other creditors.
- Find out whether the Bank's loan was the cause of the bankruptcy filing. Many times, this is obvious, but often, a borrower files unexpectedly because of pressure from other creditors. It is crucial for a workout professional to understand those pressures and how they affect the borrower and its business.
- Rule out lender liability claims. We've experienced a recent uptick in spurious lender liability claims. These are usually brought by a borrower who has both a loan in trouble and something to lose. If claims are asserted that the woes of the borrower were caused in any way by the Bank, it is crucial to identify and address those claims at the outset.
- Determine whether the Bank's claim requires engagement of counsel. Not every bankruptcy filing means that the Bank should go to the expense of hiring counsel, but it is important to make that determination as soon as possible when a bankruptcy has been filed. Experienced bankruptcy counsel, such as the JMBM Special Assets Team, can work with lender clients to determine whether counsel is necessary, and if so, what level of representation is needed.
- Send all loan documents, title policies, UCC searches and financing statements, outstandings and other relevant information to counsel immediately. If the decision is made to hire counsel, don't wait to send counsel everything that is necessary to understand the credit, the case and the history between Bank and borrower. I like to keep the loan documents on my computer in electronic form so that they are always available when my clients call or when I need to prepare a brief or negotiate with counsel for the debtor.
- Prepare and file the proof of claim. In Chapter 11, 12 and 13 cases, the Bank should promptly prepare its proof of claim and get it on file as soon as possible. This practice lets everyone else in the case know where the Bank stands, and also avoids any problems that might arise if the Bank fails to calendar the bar date and ends up filing a late claim. In Chapter 7 cases, the practice is usually not to file claims until the Chapter 7 trustee determines that there are assets to distribute. We advise our clients to review the debtor's statement of affairs and schedules and to let the Chapter 7 trustee know immediately if the debtor has failed to completely report its assets and liabilities.
In preparing the proof of claim, remember that the operative "as of" date is the date on which the bankruptcy case was filed. Don't forget to include out of pocket costs and expenses, such as legal fees, foreclosure fees, appraisal fees and the like, as well as any advances for insurance or property taxes.
- Determine whether the Bank's collateral position is sufficient. As you probably know, whether the Bank can get stay relief depends in part on whether the borrower has any equity in the property. (Equity in the property is not the lone factor in obtaining stay relief, but that topic is for another column.) The Bank's position as a fully or partially secured creditor can make a big difference in the outcome of the case.
- Determine whether the Bank is willing to allow the borrower to use cash collateral, such as rents or proceeds from accounts receivable, to operate, and on what terms and conditions. A "cash collateral" letter should be sent to the borrower as soon as the case is filed, prohibiting the borrower from using the Bank's cash collateral and requiring that cash collateral be placed in a segregated account. This will usually start the process of negotiating a cash collateral stipulation that allows use of the cash collateral in accordance with a budget and grants replacement liens to the Bank in collateral that is created post-petition.
- Work with counsel to determine a strategic response to the bankruptcy filing. Some bankruptcy filings are a declaration of war, but others are an opportunity for the Bank to work with a cooperative borrower to assist it in restructuring its debts, dealing with troublesome unsecured creditors or recovering from a reversal of fortune that has only a limited effect on the Bank's credit. The best move is to take a deep breath and methodically review the credit, the information filed by the debtor in its case and the other information available to the Bank and counsel and to set an approach to get the bankruptcy case behind the Bank and to preserve and recover the assets. Many times, the best approach is an aggressive response, but other cases call for tempered cooperative responses. There is no one best way to deal with a bankruptcy case.