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 [email protected].