Just because one of your company’s customers files for Chapter 11 bankruptcy, you do not have to wave the white flag and totally surrender the debt.
“Creditors have rights,” says Richard A. Marshack, of counsel for Shulman Hodges & Bastian LLP and a bankruptcy trustee for the United States Bankruptcy Court, Central District of California, Santa Ana Division. “The squeaky wheel gets the grease.”
For the record, under the Bankruptcy Code, a Chapter 7 is complete liquidation of a business. A Chapter 11 is usually a reorganization.
“If you get a Chapter 11 notice, do not assume that you’re not going to get paid,” Marshack says. “With a modest expenditure of time, you can participate on the creditor’s committee and make sure that your company gets as much money back as possible.”
Smart Business spoke to Marshack about how a company can protect its interests in the event that one of its customers files for Chapter 11 business reorganization.
When an account debtor files for Chapter 11, what are your preliminary options?
Many times, the debtor will initially propose a business reorganization plan that borders on lunacy, and the creditors will approve the plan before exploring their legal options. Debtors may also defer to others because they have limited resources for court cases. Both approaches are unwise.
The debtor will lead you to believe it does not have money, but you must understand it would not be filing for reorganization if there were not something to protect.
So the first step is to evaluate how much you are owed. If it is a minimal amount, it is probably not worth your time getting involved. If you are owed a material amount to your business, then you can monitor what the debtor is doing and oppose it individually or you can become a member of the creditor’s committee.
What is a creditor’s committee?
A creditor’s committee is appointed to act as the voice of unsecured creditors in the bankruptcy case. It is generally made up of the debtor’s top five to seven creditors who have the power to help shape the business reorganization plan. In some cases, the committee can be expanded to more members by the bankruptcy court. Membership involves a minimal time commitment and very little, if any, financial commitment on the part of the creditor.
The committee is entitled to hire a law firm and, if necessary, an accounting firm at the debtor’s expense. It has the right to know almost everything about the debtor.
How can a creditor’s committee influence the outcome of a Chapter 11?
A committee has an enormous amount of power:
1) It can, through negotiations, force the debtor to put in new management to take over the reorganization. Presumably, new management would be a little more benevolent to the creditor base than old management.
2) It can request that the court appoint a bankruptcy trustee to take over the business.
3) It can request that the case be converted to Chapter 7 and have all assets liquidated.
4) If the committee’s accountants believe the assets are worth more than a proposed sale transaction will pay, then its lawyers can formally object in court to the sale of those assets. For instance, after filing, the debtor may want to sell to a certain buyer, but that transaction will only pay a fraction of what is owed to creditors. 5) Under certain scenarios, the committee has the power to propose its own plan that can result in the complete elimination of existing shares of stock and reissuance of new shares to the creditors.
Each of these remedies gives the committee leverage to improve the treatment of unsecured creditors.
How are the disputes resolved without litigating in bankruptcy court?
It is often a case of quid pro quo. If the debtor gives the creditor’s committee what it wants, the committee will agree and encourage creditors to vote for the debtor’s reorganization plan. If the debtor does not negotiate in good faith, then the committee can object to the plan, and the court may then choose to reject it. The judge ultimately decides whether the plan is fair or not. He or she can order the debtor to write a new business reorganization plan which, financially, is good motivation for writing an agreeable plan the first time.
If a debtor files for Chapter 7 iquidation rather than Chapter 11, what legal options are available to creditors?
The key is for creditors to do some investigation by taking a deposition or talking to other vendors to try to find assets that may provide value to creditors. It is a common practice in a Chapter 7 for a debtor to try to hide assets from the bankruptcy court. If a debt is incurred as a result of fraudulent behavior on the part of an individual filing a Chapter 7, then the creditor can object. If the bankruptcy goes through, the debt will be excluded from the bankruptcy discharge. If such is the case, assets can be recovered, the debtor may have to pay creditors in full and the debtor may have to go to jail.
RICHARD A. MARSHACK is of counsel for Shulman Hodges & Bastian LLP and a bankruptcy trustee for the United States Bankruptcy Court, Central District of California, Santa Ana Division. Reach him at (949) 340-3400 or RMarshack@shbllp.com.