CUSTOMER FILES FOR BANKRUPTCY: WHAT NEXT?

Customers filing for Chapter 11 or 7 Bankruptcy are a fact of life, yet few companies have any standard procedures to monitor for such filings or alert them as to what procedures should be followed with the bankruptcy court.

Bankruptcy provides Debtors [formerly known as your customer] with various tools to shed contracts and financial obligations.  It also permits them to reorganize their business and sell valuable assets.  Suppliers which find themselves thrown in the mix of creditors and otherwise interested parties of the Debtor often have very little time to respond and properly determine if they should even be involved.

The First Steps of Bankruptcy:

Subsequent to the Bankruptcy petition filing and the dreaded “Automatic Stay” which freezes collection efforts against the Debtor, the Debtor will file the bankruptcy petition along with what are termed the “first day orders”.  These orders are filed to have the court approve retention of employees, special treatment for some vendors, and financing. There is very little notice of these filings/hearings.  Despite the relative lack of notice, these initial pleadings provide important clues as to the reasons for the bankruptcy and how the Debtor plans to reorganize.

Suppliers should review these filings, the schedule of assets, list of creditors and their own customer records to determine what monies are owed, whether you have interests as a critical vendor, or have received substantial payments in the 90 days prior to the filing (what could be deemed as “preferential payments”).

The first order of business for the supplier/vendor should be to determine if filing a proof of claim is appropriate.  Filing a proof of claim without first analyzing the potential risks involved is poor practice.  An avoidance action can sometimes be avoided by simply not getting involved in the bankruptcy.  Other times, filing a proof of claim will be necessary and in those cases, there are deadlines to be observed.

 Critical vendors/suppliers must act quickly in the first days of the filing to establish orders on payment for prepetition debts, wavier of avoidance actions by the Debtor and go forward credit terms.

The Proof of Claim:

Throughout the bankruptcy the court will issue orders setting deadlines for creditors to file proofs of claim.   To do so, the correct proof of claim forms with relevant contracts/invoices must be filed.  However, before filing suppliers should weight in on the possibility of recovery versus the exposure to potential preference actions.  If substantial payments were received in the months prior to the bankruptcy petition and they are arguably not in the ordinary course of business, filing a proof of claim may not be a good idea.

 While not filing a proof of claim is by no means a guarantee of avoiding a possible preference action, the act of filing the proof of claim with the court may actually result in alerting the trustee to a potential preference action against you.

A Debtor’s Assumption of Certain Contracts

A Bankruptcy Court can authorize a Debtor to assume certain contracts during the petition, assuming it meets certain conditions.  While this may sound appealing, the process is actually quite dangerous.  Suppliers seeking payment under this option must first determine what deadlines exist for them to file cure amounts.  Under this process the Debtor lists the amounts it claims are due to the supplier under the contract.  These lists however, may differ from what the supplier claims is actually owed.  Pursuant to deadlines established by the court, the supplier must object to the amounts claimed by the Debtor and identify what it believes are the correct “cure amounts”.  In the event the deadline is not met the supplier runs the risk of accepting what the Debtor claimed was owed.

Selling Assets Free and Clear

As part of a petition, Debtors often seek to sell the vast majority of their assets and file a liquidation plan.  For a supplier that has an ongoing relationship with the Debtor and has an interest in the Debtor’s assets/equipment, it is imperative to act quickly and identify the assets or equipment in which the supplier has an interest secured or otherwise.  By doing so, you put any potential purchaser on notice that there is a lien/security interest in the asset/equipment being sold.  This will be necessary in order to avoid being estopped from claiming that your interest has been extinguished by the sale.

Selling Materials Postpetition

Suppliers which have provided materials postpetition may be entitled to what is termed an administrative claim.  Such a claim, as opposed to an unsecured prepetition claim, is of higher priority.  Thus, when filing a proof of claim it is important to distinguish between materials sold prepetition and postpetition. 

Rights of Reclamation

Another scenario facing Suppliers with a Customer in Bankruptcy are potential “Rights of Reclamation.” Rights of Reclamation are defined as the right to reclaim goods shipped to a customer in financial distress (subject to certain time frames and limitations). Typically once the Debtor has filed for bankruptcy, a supplier that has not made a written demand of reclamation has a limited time frame within which to do so.

The demand must be made in writing, 45 days immediately preceding a Customer’s Chapter 11 bankruptcy filing. If however, the 45 day period expires after the bankruptcy filing, an additional 20 days is given within which to make the demand. 

 However, a Supplier can lose its Rights of Reclamation if the Debtor sells the goods, either before or after receiving the written notice of reclamation. Thus, it may become necessary to seek proper court action to prevent such sales.

 Dealing with a Customer that has declared bankruptcy can be a treacherous course to navigate. Suppliers are highly encouraged to consult their legal counsel for assistance in determining the proper course of action needed to ensure their interests.

By:       Jose A. Rodriguez, Esquire

             The Soto Law Group, P.A.