What to Do When Your Customer Files Chapter 11

It’s been a difficult year for creditors. The dour economy and timid spending from consumers has sunk enterprises across the country at a rapid pace. The rise in corporate bankruptcies has been a troubling event for credit managers to wrangle with and, ultimately, no credit professional wants to discover themselves in a position asking, “What do I do?” when one of their customers files for bankruptcy protection.

“This is a more current topic than perhaps what it was a year ago,” said Mark Berman, Esq., partner, Nixon Peabody LLP, during the CMA-sponsored teleconference “What to Do When Your Customer Files Chapter 11.” “Unfortunately, some of the things I’m going to recommend should have been done a year ago, but there’s not much we can do about that. It’s a matter of making sure you are doing things going forward that best helps you if one of your customers becomes the subject of a bankruptcy proceeding.”


Automatic stays are the first step for creditors to consider. Section 362 of the Bankruptcy Code covers automatic stays, and they are just that: no one has to ask for it or issue it, a bankruptcy petition automatically triggers it.


“The provisions in section 362 make certain things a creditor might otherwise do a violation of law,” warned Berman. “For example, a creditor cannot sue the debtor other than by going to the bankruptcy court. If the creditor has a lien on the customer’s assets, as you would if you were a secured creditor, you cannot foreclose against those assets. You can’t conduct a foreclosure sale and you can’t notice a foreclosure sale, so you have to first go to the bankruptcy court for permission to proceed.”


Berman also covered stopping goods in transit and reclamations, plus administrative priority for suppliers of goods, creditors’ committees, proofs of claims, executory contracts as well as doing business with a Chapter 11 debtor.


Berman advised that credit managers should also be proactive in protecting themselves from the repercussions of their customer’s filing for bankruptcy protection and dreaded preference claims by determining whether a customer should be sold to on credit terms, COD or on a cash-in-advance basis. The advantage of these strategies is that goods sold on a cash-in-advance basis will never be subject to a preference claim since a preference requires that a payment be received on an account of sale of goods and ascendant before the payment was made.


“If you’re receiving payment in advance, you could never be receiving that payment on an ascendant of debt,” explained Berman. “The payment in advance protects you from preference recovery.” He noted that most credit managers run into problems by requiring not just payment in advance but also a payment on arrearage. That makes that payment on the old debt potentially preferential.


He recommended that credit managers consider whether or not sales should be backed up by some sort of collateral.


“Banks lend money oftentimes on a secured basis,” said Berman. “There’s no reason why you can’t condition your sales to being on a secured basis. And I would include in security, letters of credit or guaranties or purchase money security interests as well as just regular secured interest as means to enhance the chances you are going to be ultimately paid.”

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