The Small Business Creditor

by Paul D. Sinclair

So your small company has just, unexpectedly, become a creditor in a small bankruptcy. The standard reaction is to write off the money or file a claim and hope to get paid. The issues below will help evaluate your other choices.

 

Proofs of Claim

So do I file a proof of claim? The knee jerk reaction is that you do. This is not necessarily the correct answer. First, is there really going to be any distribution? If all the money is going to a bank, it may not be worth the effort. In a Chapter 7, there will sometimes be a filing deadline, if there are assets. The Chapter 7 Notice of a Section 341 Meeting of Creditors will typically say whether there is a deadline. In a Chapter 11, a Notice may be received of a Bar Date, or final deadline by which you must file a claim. What may stop you from wanting to file a claim? The question is: Are you going to be sued for a preference? If you file a claim, you waive a right to jury trial, and this can be a major strategic mistake.

 

Preferences

Preferences are payments or transfers by a debtor to a creditor within 90 days prior to the bankruptcy. If you have received any payments, the bankruptcy trustee may ask for them back. Thus, the debtor may owe you $200,000 when it files, and the trustee will ask you to refund an additional $125,000 you received to pay one of your invoices 84 days ago. There are many complicated defenses, but because a number of bankruptcy judges tend to favor the debtor, having a jury is a good thing. The preference period for an insider, a relative or family member, is a one year period.

 

Post-petition Credit

So the debtor owes you $100,000, it’s filed in bankruptcy, and now it still wants you to sell on 15 day payment terms, thus extending new credit. Should you do so? This is a business and not a legal decision. However, the legal context is that post-petition claims have priority and should be paid dollar for dollar—if the post petition estate is solvent. In other words, there is a dividing line between whether the transaction was before or after the person filed bankruptcy. Is the post-petition estate functioning with positive cash flow? For example, did the debtor just file in bankruptcy because of a huge unexpected judgment that does not effect the basic soundness of its business plan? Are banks or other lenders continuing to extend post-petition financing to the debtor? 

 

Automatic Stay

What is the automatic stay? The automatic stay is a broad federal injunction, effective on the filing of any bankruptcy proceeding, which stops any acts to start or continue any enforcement actions against the debtor or its property. Not infrequently, bankruptcies are filed giving the debtor breathing room by stopping pending foreclosure actions or collections on judgments which would stop the debtor’s business from functioning. The creditor who wants to collect may move to lift the stay, but that depends upon a number of factors including whether the debtor has equity in the asset, whether it has an effective strategy for reorganization or liquidation, and whether the debtor has had enough time to develop its possibilities. The quicker the creditors seek to lift the stay, the less chance there is to lift the stay in some settings. The penalties against creditors for violating the stay can be quite harsh, so it is essential to respect its scope and effect. If a creditor has some potential notice of a bankruptcy in the middle of a collection action, such as the repossession of a car, it has a duty to seek out and determine the facts, rather than just proceeding because it has not received “formal” notice.

 

These are some highlights. Congress has given us a Bankruptcy Code which is just as simple, logical and straight forward as the Tax Code. There are policy decisions, or more likely, lobbying successes, which have added immeasurably to its opaque nature. However, like taxes, dealing with financial failure is an inevitable cost of doing business.

Paul D. Sinclair is a Shareholder, Shughart Thomson & Kilroy, P.C. 
P     |    816.421.3355
E     |    psinclair@stklaw.com