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 [email protected].