Steve Sneiderman, an attorney at Hahn Loeser + Parks, has a cautionary tale about one of his clients, a supplier who made a very untimely delivery the week before a large local steel company filed for bankruptcy.
“It was a small company, a fuel supplier,” says Sneiderman. “He had an open purchase order with the company for twice the normal amount of fuel he usually delivered. The company agreed to reduce their terms from 30 days to seven days, and then three days later they filed for bankruptcy.”
His client was trying to protect himself but now stands in line with thousands of other debtors for the money owed.
“They assured him they had plenty of cash, and they would be paying him,” says Sneiderman.
But in the end, his client was out close to a million dollars and at the mercy of a protracted bankruptcy proceeding.
“He got frustrated and asked, ‘What are you guys doing for me?’ but we are limited by the law,” Sneiderman says.
Once a bankruptcy has been filed, most creditors’ hands are tied.
“In the purest sense of the law, bankruptcy is intended to frustrate creditors, literally slow them down from being able to exercise their rights and in many cases completely stop them,” he says.
But there are a few things Sneiderman suggests doing when dealing with a company on the brink of or in bankruptcy proceedings.
Get your own house in order
When dealing with a company on the brink of bankruptcy, this often means doing a little spring cleaning. Sneiderman suggests an “out with the old, in with the new” policy.
“We ask our clients if they have any contracts out there that they have the ability to terminate now,” he says.
Sneiderman stresses that companies should always re-evaluate existing contracts, but once the rumors start regarding a pending bankruptcy, the key is timing.
“When you know that someone is in trouble, the first thing you should do is ask, ‘How are we legally related to these people and what is our potential exposure?'” he says.
Play out all possible scenarios.
“What if they file tomorrow, then what happens?” he says. “If they don’t file tomorrow, what can I do between now and when that happens to reduce the risk?”
You have the legal right to terminate a contract as long as doing so doesn’t breech the existing agreement. If you’ve had the foresight and done the planning, there should be a 30-day clause allowing for termination. But this is much easier to do before the filing because, as Sneiderman says, “The magic of bankruptcy is that the debtor has all the cards.”
The other means of minimizing risk is to manage your receivables. In some cases, that means cutting down your payment terms or even demanding cash on delivery. The shorter the terms the better, as his client learned the hard way.
“A lot of times a supplier is willing to trade off those termination rights for a longer term commitment or pricing differences,” he says. “They may not know the day they sign the contract how great the risk is.”
This is the end
If you find yourself on the creditor side of a bankruptcy, it’s important to know your rights and liabilities. If you’re not able to terminate a contract before a company files, the proceedings go to the court and your ability to negotiate is cut off.
“After a bankruptcy, you cannot negotiate on the debt that is owed,” says Sneiderman. “If you do, you could go to jail for violating the automatic stay.”
Negotiation on monies owed before the filing is strictly verboten.
“It is called an executory contract because it is open and because once the bankruptcy is filed, the debtor then has the option to assume the contract and compel performance,” Sneiderman says.
Compelled performance is, for the most part, as unappetizing as it sounds and means you must abide by the original agreement.
The fact is that although the debtor is required to give “adequate assurance” that the creditor will be paid the balance of the contract, anything outstanding from before the date of the bankruptcy filing is left for the court to resolve.
Also watch out for payments made within 90 days of a filing. Sneiderman says that any payment that demonstrates preferential treatment is subject to reclamation by the court.
“The idea is that if I’m the bankrupt company and I know I’m going to file and I need to keep you happy, I will pay you as opposed to paying these guys over there and I’ve treated you preferentially,” he says.
If a trustee deems preferential treatment, you must relinquish the funds, and that could cause more grief than not getting the money at all. There are a number of defenses, but if a payment is out of the ordinary or not in the terms of the original agreement, it is best to not count on those funds as solid assets.
However, reclamation in some cases works both ways. In the case of products sold, “You have the ability, if you haven’t been paid for sales of goods within 10 days of the filing, to go back and reclaim those goods,” says Sneiderman. “If the goods are gone, then you have the right to demand payment in full.”
Again, the key is timing. It’s best to file that claim as soon as possible after the bankruptcy filing.
Life after bankruptcy
Any bankruptcy filing that catches you off-guard is going to hurt. But in many cases, not all is lost.
“The flip side of it is that now it is a new negotiation if you don’t have a contract that is being assumed,” Sneiderman says.
Everything starts over, new contracts can be brokered, “and bankrupt companies expect not to get the most favorable terms.”
Sneiderman suggests you not burn your business bridges.
“A lot of companies can go through bankruptcy and come out strong,” he says.
Why lose out on more money by holding a grudge when you are now free to negotiate contract terms that will minimize your company’s exposure? How to reach: Hahn Loesser + Parks, (216) 274-2520
Kim Palmer ([email protected]) is managing editor of SBN Magazine.