Creditors’ rights Featured

7:00pm EDT January 29, 2008

Learning that a customer has filed bankruptcy and is seeking to discharge obligations is unsettling. But there are steps a creditor can take to protect its rights and position itself in the bankruptcy process, according to Andy Kight, shareholder/director of Sommer Barnard PC, who concentrates his practice on business workouts, bankruptcy and creditors’ rights issues.

Smart Business spoke with Kight about the bankruptcy process and how a creditor can navigate through the process.

Is it worthwhile for a company to get involved in a customer’s bankruptcy process?

Creditors often assume that participating in the bankruptcy process is simply throwing good money after bad. It is true that not every case results in a distribution, but the failure to confirm that a claim has been scheduled or to file a proof of claim guarantees that the creditor will receive no distribution. In addition, bankruptcy may actually provide the creditor with an opportunity to obtain more favorable credit terms by continuing to do business with a reorganizing debtor. The cost to position oneself in the bankruptcy process is usually modest, so creditors are encouraged to take these steps at the outset of every case.

What is the first step a creditor should take?

Once a customer files a Chapter 11 reorganization, an initial decision should be made on how to treat the customer going forward. Just because credit was extended before bankruptcy does not mean the bankrupt company has a right to continue operating under the same terms. Ordinarily, nothing requires a vendor to continue doing business with a debtor. A vendor that shipped on credit pre-bankruptcy might consider converting to prepay or C.O.D. terms post-petition, or it may choose to stop shipping altogether.

However, new terms or stopping shipments altogether cannot be imposed in every instance, and a creditor may not coerce a debtor to make payments on a prepetition claim. If the creditor and the debtor were operating under a supply contract or other written agreement prior to bankruptcy, the debtor may have the opportunity to assume or reject that contract or agreement during the bankruptcy case. Until that decision has been made, both the vendor and the debtor should continue performing under the agreement. Before demanding such changes, the vendor should assess its arrangement with the bankrupt company and determine whether it is operating under a contract subject to assumption or rejection.

What is a proof of claim, and does a creditor necessarily have to file one?

At the outset of a bankruptcy case, the debtor is required to file certain documents setting forth a summary of its financial condition and listing all claims that exist against it at the time the case is commenced. In a Chapter 11 reorganization, unless a claim is listed as disputed, contingent or unliquidated, a scheduled claim is deemed allowed. The safe practice, however, is to always file a proof of claim.

In a case under Bankruptcy Code Chapters 7, 12 and 13, a proof of claim must generally be filed within 90 days after the first date set for the initial meeting of creditors. In a case under Chapters 9 and 11, a proof of claim must be filed within the time fixed by the court.

In calculating its claim, a creditor generally should include all amounts provided for in its purchase orders or contract, such as interest, late fees and attorneys’ fees. In addition, copies of the documents upon which the claim is based, such as the contract, agreement and even an account summary, should be included with the proof of claim.

Are there any other rights creditors may be able to assert?

One possibility creditors may consider is pursuing a non-dischargeability action. In certain instances, including when a debtor obtains goods or services through fraud or misrepresentation, a debt may be found to be non-dischargeable. While creditors are enjoined from seeking to collect claims that have been discharged, the liability on a nondischargeable debt survives bankruptcy, and may be pursued once the automatic stay terminates. A non-dischargeability action is commenced by filing a complaint with the bankruptcy court. Because the time to do so is strictly enforced, and because the process may be complicated, creditors are encouraged to consult with an attorney to determine the feasibility of pursuing such an action.

In addition, the 2007 amendments to the Bankruptcy Code provide creditors the ability to protect themselves with respect to unpaid shipments made to a debtor in the days leading up to bankruptcy. Upon proper request, Section 503(b)(9) allows a creditor to assert an administrative claim for the value of any goods received by the debtor within 20 days before the date the case is commenced if those goods were sold to the debtor in the ordinary course of its business.

Bankruptcy priorities provide for payment of allowed administrative expense claims after satisfaction of secured claims but before payment of priority and general unse-cured claims. To the extent secured claims are not fully satisfied, 503(b)(9) administrative claimants run the risk of nonpayment. The ability to assert this claim, however, is a tool that should not be overlooked, regardless of the outlook of a bankruptcy case at filing. Creditors that deliver unpaid goods to a debtor in the days before bankruptcy are therefore urged to investigate and assert this valuable right.

ANDY KIGHT is a shareholder/director of Sommer Barnard PC. Reach him at (317) 713-3572 or