Bankruptcy laws get modified every year or two. But in October 2005, a major overhaul by Congress resulted in a significant paradigm shift.
“Two years later, a lot of people do not realize the extent of the bankruptcy law changes, their impact and how they play out in real cases,” says Mark Bradshaw, a partner in the Insolvency and Reorganization Practice Group at Shulman Hodges & Bastian LLP. “If you’re dealing with a company that appears to be in financial distress, you definitely want to contact your attorney right away.”
Smart Business asked Bradshaw about how to minimize the impact of lawsuits originating from companies that have filed or are in the process of filing for Chapter 7 or Chapter 11 bankruptcy protection.
What changes in the bankruptcy law were implemented in October 2005?
Although the law that enacted the changes, in part, is named the Consumer Protection Act, the law favors the rights of creditors. Here are some changes. 1) Venue. Previously, certain lawsuits within the bankruptcy realm were filed and tried wherever the debtor filed. Defendants not only had to spend money to defend themselves, but they often had to do it in a foreign jurisdiction chosen by the debtor. With some exceptions, the trial is now located where the defendant, or the creditor, is located, not where the debtor files its bankruptcy. That helps defendants in terms of cost and convenience. 2) Reclamation. Reclamation is the procedure by which a creditor that has supplied goods may seek the return of those goods from a company that files bankruptcy. There was already a procedure for reclamation claims, but the timeline was essentially only 10 days. Under the new law, the supplier still must make a written demand, but it now has 45 days from the date goods were received or 20 days after the bankruptcy is filed if the 45 days have not expired. This is a powerful and under-utilized tool for improving a creditor’s position when faced with a bankruptcy. 3) Creditors as landlords. Under the old code, a debtor/tenant had 60 days to decide to either assume or reject a lease, but that 60 days was routinely extended numerous times. Now, the limit is 120 days, with only one further extension for cause, unless the landlord consents to additional extensions. The changes to the law give the landlord more certainty and control in the process of lease assumption and rejection.
What is preference law, and how does it impact debtors and creditors?
Preference law is an area of bankruptcy that has often irritated business owners. The philosophy behind the law is that bankruptcy seeks to treat creditors the same so that a creditor that receives a payment is not preferred to other creditors that do not receive payments.
A creditor that is paid by an insolvent debtor outside of 90 days before the bankruptcy filing is immune. But within that 90 days, the creditor risks being sued.
How can you tell if a customer/debtor is ‘distressed’?
It is important to watch payment patterns and the creditworthiness of your customers. You may not always know if your customer is insolvent on a balance-sheet basis, though you may have clues that your customer is equitably insolvent (i.e., not paying bills as they come due).
Customers in trouble may start paying beyond the stated term of the invoice or beyond the ordinary course of dealing with you. The customer may start paying only a portion of the amount due or start claiming an offset or recoupment right. There are often warning signs.
How do you protect yourself from preference actions?
The most important steps are to be prepared and to be informed about your rights. Creditors usually react rather than anticipate. A creditor should occasionally be surprised by its customer’s bankruptcy filing, but they should never be surprised if they get sued for a preference. Debtors are certainly getting the advice of attorneys, which includes prebankruptcy planning.
The changes to the law have made it easier for the defendant/creditor to prove an ‘ordinary course of business’ defense to a preference lawsuit. The test used to be conjunctive; the defendant had to prove A, B and C. Now the defendant just has to prove that the payment at issue was made in the ordinary course of business of the debtor and defendant or that the payment was made according to ordinary business terms.
In every Chapter 7 and some Chapter 11s, a trustee is appointed and is in charge of all decision-making with respect to the debtor. Trustees are extremely familiar with the bankruptcy process and preference lawsuits, and routinely hire attorneys.
An unsophisticated or unrepresented creditor is at a distinct disadvantage and may enter into an unfavorable or unwar-ranted settlement. You do not have to be that company. Do not wait until the bankruptcy is filed or a preference lawsuit is filed against you.
MARK BRADSHAW is a partner in the Insolvency and Reorganization Practice Group at Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or firstname.lastname@example.org.