Supply Chain Bankruptcy Preference Releases: Good News for the Credit Team, But Watch for the Claim Offset, By: Scott E. Blakeley, Esq.

As originally published in the Credit Research Foundation 2Q 2018 Credit & Financial Management Review

Abstract

In managing credit risk with an insolvent customer, the seasoned credit team also appreciates not just the A/R risk, but the preference risk should the customer file bankruptcy, or an out of court liquidation such as an Assignment for Benefit of Creditors. In some settings, suppliers may have larger exposure with preferences than with A/R. The welcome news for suppliers is that a number of large Chapter 11 filings have included supplier preference releases as part of their negotiated exit from Chapter 11. But with a provision in a Chapter 11 that provides for a preference release, suppliers holding priority claims should be mindful that the debtor may take back the supplier chain preference release through a reserved claim objection.

The Bankruptcy Preference

The Bankruptcy Code vests the trustee with far-reaching powers to avoid payments to suppliers within 90 days prior to a bankruptcy filing, and is one of a debtor’s most potent weapons to discourage a supplier’s collection strategy of racing to the courthouse to seek a judgement against the insolvent customer.

Supply Chain and One-Off Preference Release

Several high-profile companies have exited Chapter 11 with a plan of reorganization that provides for release of preference actions against the supply chain. Recent case examples include Rue 21, Haggens Supermarkets, Gordmans and Central Grocers. These cases highlight the Chapter 11 exit strategy in two settings: (1) a sale of assets, with an asset purchase agreement negotiated between the debtor, the buyer and creditors’·committee, that includes a preference release; or (2) an operating plan negotiated by the debtor, secured creditor and creditors’ committee that includes in the Disclosure Statement and Plan, a preference release. In both settings, title supplier qualifies for the preference release by offering credit terms for their product or service to the buyer or reorganized debtor upon exit from the Chapter 11.

If the debtor does not propose a supply chain preference release, the supplier may seek to negotiate a preference release only for its own potential liability. The one-off preference release is commonly through a negotiation of supplier trade terms in exchange for early payment of the supplier’s 503(b)(9) claim.

With the sale of asset cases, a Trust is created for purpose of retaining the estate’s preference actions and sale proceeds. The party responsible for the Trust’s assets is often referred to as a plan administrator. The responsibilities of the plan administrator are to maximize the Trust’s assets and limit its liabilities. One way to limit liabilities against the Trust is through plan administrator objections to claims submitted by suppliers.

A claim objection can be such things as books and records-the debtor’s reconciliation of the supplier’s claim does not match, or a late filed claim. Another strategy for the plan administrator to reduce claims is object to a supplier’s claim based on the supplier having received a preference. But does such an objection have merit where the Plru1 provides for a supply chain preference waiver? Is such an objection, selective enforcement of the preference powers as these types of claim offsets are commonly asserted against suppliers, asserting 503(bX9) claims?

Claim Objection Based on Preference

A plan administrator may object to a supplier’s claim, most likely a 503(b)(9) claim, under section 502(d) of tl1e Bankruptcy Code. Section 502(d) provides, in pertinent part, that “the court shall disallow any claim of any entity from which property is recoverable “under the preference statute, unless the preference is repaid.

How might a plan administrator support a section 502(d) claim objection where a debtor under a confirmed Plan releases suppliers from preferences?

For example in In re Gordmans, the confirmed Plan (at Article VII. paragraph F) provides:

Any Claims…recoverable under section …547 of the Bankruptcy Code, shall be deemed disallowed pursuant to section 502(d) of the Bankruptcy Code…

However, Article VIII, paragraph C of the Plan provides an unconditional preference release to suppliers from preferences. Thus, the question for a supplier holding a 503(bX9) claim is whether a plan administrator may disallow the supplier’s claim under section 502(d) on the grounds of an alleged preferential payment, even though a preference action cannot be filed as a result of the preference release.

Does the Legal Authority Support the Supplier Dealing with a 502(d) Claim Objection?

In most Chapter 11 cases, suppliers holding non-priority claims generally do not receive a distribution. Rather, only those suppliers holding priority claims. Generally 503(b)(9), receive a distribution. Therefore, in most Chapter 11s, the plan administrator’s focus with claims·objections, including 502(d) objections, is against priority claimants.

Fortunately, the majority of courts hold that section 502(d) does not apply to 503(b)(9) claims. In re Lids Corp., 260 B.R. 680, 683 (Bankr. D. Del. 2001) (“administrative expense claims are accorded special treatment under the Bankruptcy Code and are not subject to section 502(d)”); In re Durango Georgia Paper Co., 297 B.R. 326, 331 (Bankr. S.D. Ga. 2003) (“Section 502(d) does not apply to administrative expenses that are allowable under § 503”); In re Plastech Engineered Prod. Inc., 394 B.R. 147, 161 (Bankr. E.D. Mich. 2008) (“the allowance of claims
under § 502 is entirely separate from the allowance of administrative expenses under § 503”); In re Ames Dep’t Stores. inc., 582 F.3d 422,427-432 (2d Cir. 2009) (“[w]e hold that section 502(d) does not apply to admin istrative expenses under section 503(b)”); In re Tl Acquisition, LLC, 410 8.R. 742, 750-51 (Bankr. .D. Ga. 2009) (“Section 502(d) does not contain any language or reference which would make it applicable to administrative expenses of any kind”‘); In re Momenta. inc., 455 8.R. 353. 364 (Bankr. D. .H. 20 1 1) (“Because § 502(d) is inapplicable to administrative expense claims, including an expense requested under § 503(bX9). the claim shall be allowed”); Jn re Energy Conversion Devices, Inc., 486 B.R. 872, 878 (Bankr. E.D. Mich. 2013) (“1l1e Court is persuaded that the correct reasoning and views are those taken by the Second Circuit in the Ames Dep ‘t Stores case, regarding § 503(b) administrative expenses in general, and by the courts in the Plastech and Momenta cases, regarding § 503(bX9) administrative expenses in particular”); In re Quantum Foods. UC,554 B.R. 729, 735 (Bankr. D. Del. 20 16) (“Section 502(d), by its terms, does not include administrative expense claims. Conversely, § 503, which addresses administrative expense claims, has no provision similar to 502(d) disallowing administrative claims if the administrative claimant fails to satisfy a preference liability”).

The minority position is that § 502(d) applies to all claims, including administrative expenses. In re MicroAge, Inc., 29 1 B.R. 503, 508 (B.A.P. 9th Cir. 2002)(“[W]e believe that the better analysis is that §502(d) may be raised in response to the allowance of an administrative claim”); In re Circuit City Stores, Inc.,426 B.R. 560, 571 (Bankr. E.D. Va. 20 10) (“(T)he Court concludes that § 502(d) may be used to temporarily disallow § 503(bX9) claims”).

Supplier·Strategy to Ensure Priority Claim is Free from 502(d) Objection

If the supplier has a provision in a confirmed Plan that provides for a supply chain preference release, the next step is to confirm that a 502(d) claim objection is not preserved by the plan administrator. If so, consider objecting to that provision of the Plan.

If an objection to the Plan is not lodged, the supplier still has an alternative to preserve the priority claim. The court in In re Energy Conversion ruled that a provision in a confirmed plan does not override Congressional intent. In In re Energy Conversion, the Trustee requested the court delay payment of a supplier’s 503(b)(9) administrative expense until after the preference claim against it had been determined. The Court explained that, whatever discretion a court may have to allow a Chapter 11 debtor to defer paying allowed administrative expenses before a plan is confirmed, such discretion no longer exists once a plan has been confirmed; the confirmed plan controls when allowed administrative expenses must be paid.

Supplier Takeaway

As more large Chapter 11 debtors are considering supply chain preference releases, the supplier, especially one holding a 503(b)(9) claim, should be vigilant as to whether the plan administrator seeks to retain 502(d) claim objections. lf a supplier preference release is obtained, but 502(d) claim objections are retained, consider objecting to that provision. Otherwise, case authority supports the 502(d) claim objection be overruled.

Scott Blakeley, of Blakeley LLP, advises companies regarding creditors’ rights and bankruptcy law. His email: seb@blakeleyllp.com

Can the bank seize these goods, even though the creditor and supplier agreed they were on consignment?

Editor’s note: The following article originally appeared in Credit Today, the leading publication for the credit professional, a CMA Partner. Click here for Special CMA Member $10 Trial!

“We just heard you’re going to be selling off inventory from Claire’s Concrete, Inc.,” said Florence Sherman of FirstRate Concrete.

“That’s right,” replied Joe Kaplan of WestEnd Bank. “We had a security interest in all of Claire’s inventory.”

“Well, a lot of the raw materials Claire’s had belonged to us,” Sherman said. “We sent them materials on consignment. If they didn’t sell, we could take them back. Or, if we needed material manufactured into specific forms, we had Claire’s do the work, and we paid for it. So, we’ll be taking those materials back.”

“I see no indication that those materials belonged to you,” Kaplan replied.

“Look on the inventory sheets. Some of the materials have ‘FR’ in front of them. That means they belong to us.”

“But I can’t tell by looking in the warehouse which material is which,” Kaplan complained. “You didn’t post a sign. I didn’t find any UCC filing that identified your interest in any of these materials.”

“We didn’t have to file under the UCC,” Sherman snapped. “Claire’s knew which goods were which, and we had a firm understanding that our goods were to be kept separate from theirs.”

“Do you have this agreement in writing?” Kaplan inquired.

“No, it was an understanding,” Sherman stressed.

“Well, if you wanted to protect your interest in your raw materials, you should have identified them,” Kaplan repeated. “As a secured creditor, I must be able to come in and decide what goods belong to whom. The way things look, it appears everything belongs in Claire’s inventory. We’re going on with the sale.”

Can WestEnd Bank sell all the raw materials?

Yes they can.

Under the UCC, if goods are “delivered to a person for sale and such person maintains a place of business at which he deals in goods of the kind involved, under a name other than the name of the person making the delivery, then with respect to claims of creditors of the person conducting the business the goods are deemed to be on sale or return.”

Therefore, when Sherman shipped raw materials to Claire’s, they became part of Claire’s inventory since Claire’s dealt in the same goods as the type Sherman shipped.

Had Sherman wanted to protect her company’s interest, she should have either posted a sign near those specific raw materials to evidence her company’s interest in the goods or she should have filed a security interest. Because she did not take either step, the court found the bank had priority, and ruled that all of the raw materials belonged to the bank.

This article originally appeared in Credit Today, the leading publication for the credit professional.
Click here for Special CMA Member $10 Trial!

How Credit Managers Can Help their Bankrupt Customers

Recent news that Sears Canada has failed in its efforts to compete an effective reorganization, and will be forced to liquidate through Canada’s equivalent of Chapter 7 bankruptcy, has brought to light a point often ignored in analyzing your strategy with respect to money owed to a customer in bankruptcy.

For example, pretend for a moment that you’re on the committee in the Sears case. You’re meeting with attorneys and discussing potential bids. Something seems strange about these bids and you’re unable to get behind the low prices being offered. Additionally, your attorney tells you that you’ll get more back on your claim through a liquidation. Well, this is obvious, right? Vote against the plan for a sale and go to liquidation.

Retail bankruptcies are throwing a huge wrench in the business landscape these days. Liquidations are becoming more and more tricky because buyers are becoming harder to find. With so many bankruptcies in one sector, valuations are inherently lowered. According to a recent article in the American Bankruptcy Institute, trade creditors reaching compromises in retail bankruptcies are causing a real positive impact on the road to recovery. If investment firms who are owed enormous amounts of debt liquidate, the recovery for trade creditors is very little. However, a meaningful reorganization means money coming back to the creditors’ companies in the form of settlements and continued business.

As a credit manager serving on a committee, one may be tempted to take the money and run as quickly as possible. However, as this article posits, sometimes it’s much better to have a long-term relationship that a small instant recovery. The over-leveraged company is more and more commonplace after nearly 10 years of interest-free money. Credit managers who take a more long-term view of the issue may end up with a better impact for their company than simply taking what a liquidation would allow. Next time you’re faced with this situation, feel free to call CMA Adjustments for more information on how a different view of your bankruptcy claim could provide a positive impact on your company in the long-term.

Customer Receipts- 503(b)(9): New Ruling in In re ADI Liquidation casts further doubt on ability to recover goods from bankrupt customer, by Molly Froschauer

If your company sells to a customer and delivers goods within 20 days of the customer filing for bankruptcy, one may believe that your company may have an administrative (highest priority) claim for the value of those goods. As many credit managers know, however, the claim under 503(b)(9) of the bankruptcy code has many problematic caveats with the way we do business today.

Many companies use intermediaries like fulfillment houses to deliver goods to customers. This issue has been taken up several times but the recent case presents an interesting twist on the same issue.

The Debtor in this instance, was a billing and servicing platform through which its customers would order items. The manufacturer and distributor would deliver directly to the Debtor’s customers and the Debtor would remit payment for those goods minus its fee, to the manufacturer. The question in front of the court was whether a third-party partner who never possesses the goods, but who possesses the payments for goods recently delivered, constitutes a receipt by the debtor. The court held it does not.

“With continuing complexity in billing and delivery systems in business today, it’s important to consider the implications of third-party partnerships when delivering goods to a party that does not directly owe your company money.”

Current case law requires physical possession of the goods by the Debtor. With third-parties being utilized for help in distribution, billing, customer service and many other aspects of business today, it’s important to understand the impact of everyone in your value chain. At any point, one part of the chain could file for bankruptcy and despite the spirit of 503(b)(9)’s intent to compensate recently-delivered goods, the fact that the end-user doesn’t pay your company directly creates greater risk.

These issues are circling the appellate courts currently and further clarity is sure to develop. One can hope that the spirit of the statute, fairness to trade creditors, is once again respected in light of the complicated supply and distribution chains existing in today’s business climate.

Molly Froschauer is the General Manager of CMA Adjustments. She received her J.D. cum laude from Pepperdine University and her Bachelors from Claremont McKenna College. Before joining CMA, her practice was centered around bankruptcy and other out-of-court debt issues. She’s a member of the Bankruptcy Inn of Court, Los Angeles Bankruptcy Forum, and the Turnaround Management Association.

Ninth Circuit Court of Appeals Finally Hears the Credit Card Surcharging Argument, by Wanda Borges, esq.

By: Wanda Borges, Esq.
Borges & Associates, LLC

Those companies which are still following credit card anti-surcharging litigation know that the case of Italian Colors Restaurant v. Harris (as Attorney General of the State of California) has been sitting still before the 9th Circuit Court of Appeals for more than two years. The United States District Court for the Eastern District of California, on March 23, 2015 ruled against the California statute which prohibits the pass-through of credit card surcharging. The pertinent statute (California Civil Code section 1748.1) says: No retailer in any sales, service, or lease transaction with a consumer may impose a surcharge on a cardholder who elects to use a credit card in lieu of payment by cash, check, or similar means. A retailer may, however, offer discounts for the purpose of inducing payment by cash, check, or other means not involving the use of a credit card, provided that the discount is offered to all prospective buyers.

The U.S. District Court found the statute to be unconstitutional and permanently enjoined its enforcement. The California Attorney General filed an appeal to the 9th Circuit Court of Appeals and there the case has sat. It is this writer’s impression that the 9th Circuit was waiting to see what would happen with the New York case of Expressions Hair Design which was to be heard by the United States Supreme Court.

On March 29, 2017, the U.S. Supreme Court vacated the decision of the 2nd Circuit Court of Appeals which left the New York statute to be deemed unconstitutional as District Court Judge Rakoff had determined. On August 17, 2017, the 9th Circuit Court of Appeals finally heard oral argument on the Italian Colors v. Becerra (the current Attorney General of California substituted for Harris). What was most interesting was the Attorney General’s statement that California permits dual pricing as long as it is clear and conspicuous. He said that the statute means a merchant cannot post a single price and then add on a surcharge.

A strict reading of the statute would not agree with that statement. The 9th Circuit panel often referred to the Supreme Court decision in the Expressions Hair Design case and seemed to be leaning towards mimicking the Supreme Court in declaring the California statute to be unconstitutional and allowing a surcharge to be added provided it is clearly and conspicuously noticed. It was also interesting to note that both sides consistently argued that the surcharge prohibitions exist to protect consumers. This supports the opinion that the passing through of credit card surcharges is perfectly permissible for business-to-business transactions. It may take several months for a decision to be handed down but at least the 9th Circuit has moved forward on this matter.

WANDA BORGES, ESQ. is the principal member of Borges & Associates, LLC, a law firm based in Syosset,
New York. For more than thirty years, Ms. Borges has concentrated her practice on commercial
litigation and creditors’ rights in bankruptcy matters, representing corporate clients and creditors’
committees throughout the United States in Chapter 11 proceedings, out of court settlements,
commercial transactions and preference litigation. She can be reached at 516-677-8200.

New Webinar Series Helps Credit Professionals Understand Bankruptcy

As a risk manager, you know that bankruptcy by your customers is one of the biggest threats to try to avoid. But what happens when your good customer files bankruptcy? CMA has put together a series of webinars addressing bankruptcy and what you can do to understand the process in order to help your company get paid.

These sessions will guide you to:

  • Understand the difference between the major types of corporate bankruptcy, and what happens to outstanding debts when your customers file.
  • How anti-trust laws can affect a bankruptcy.
  • Learn about your company’s rights when your customer files bankruptcy.

Webinars are:

Sign up for these and other events at http://www.anscers.com/upcomingevents.aspx or contact CMA Member Relations, at 800-541-2622.

CMA Adds Commercial Real Estate Sales to Liquidation Services

By Molly Froschauer

Credit Management Association (CMA) Adjustments exists to help serve the creditors in the bankruptcy process by ethically handling assets and distributions in a cost-effective manner. As many businesses know, once a company files bankruptcy, the process can be so costly that the creditors lose out. As CMA Adjustments prides itself on being a full-service solution to companies looking to maximize their assets for their creditors in an alternative to bankruptcy, it has added real estate to its capabilities.

Once a company is out of business, the rules for payments, collections and distributions all transform and often require a third party to handle assets to ensure fairness to creditors. Often these third parties are attorneys or financial analysts whose services cost an enormous amount due to the expertise required. At CMA, we have handled all kinds of commercial assets for more than 130 years, and we have been cognizant that many times, recovery will come from the sale of real estate. We believe that the creditors will benefit by adding these assets to the liquidation processes.

Whether the funds come from collecting rents, managing properties or liquidating buildings, CMA manages the funds of insolvent estates with the creditors in mind. CMA is also available as a resource for companies to ask questions about any part of this process. For example, many creditor managers run property records as part of the credit application and have questions about real estate’s impact on the creditors’ right to recovery. With this new expertise, CMA has expanded its ability to help companies drill down on any asset that affects their recovery.

I’d love to talk to you in more detail about this program if you have any questions. Please feel free to call me at 818-972-5300 or email me at molly@cmaadjustments.com.

About CMA Adjustments

Frequently, a company suffering from the effects of diminished cash flow seeks relief from its debts through a bankruptcy proceeding. CMA Adjustments offers effective alternatives to bankruptcy. CMA’s fully developed and tested programs reorganize debt and rehabilitate insolvent companies at a fraction of the costs and none of notoriety that bankruptcy carries.

Through CMA’s out-of-court workouts management can work informally with creditors to reorganize debt or position a company for merger, acquisition or new investment. If liquidation is appropriate, CMA has extensive experience as assignee under an assignment for the benefit of creditors for most types of businesses.

Molly Froschauer is the General Manager of CMA Adjustments. She received her J.D. cum laude from Pepperdine University and her Bachelors from Claremont McKenna College. Before joining CMA, her practice was centered around bankruptcy and other out-of-court debt issues. She’s a member of the Bankruptcy Inn of Court, Los Angeles Bankruptcy Forum, and the Turnaround Management Association.

What Can You Expect When You Instruct Your Collection Agency to ‘Go Legal’ Against Your Former Customer, by Sam Fensterstock

Let’s say that you have placed your former customer for collection and your agency demands, as well as the local attorney, demands have not been successful. Your agency along with your attorney believe that litigation is your only option in hopes of being paid, provided that the amount due falls above your suit parameters. Had the former customer filed for bankruptcy, you can forget about a lawsuit and write off the receivable. In this situation, if you want to have any chance of collecting, your agency along with your attorney will review all documentation supplied along with a review of their internal efforts and investigation and make a recommendation to you regarding the filing of a lawsuit in the debtor’s locale.

SOME THINGS TO CONSIDER BEFORE FILING

Upon agreeing to litigate, your agency will then provide your attorney all of the information they have on your claim including amount due, principal and interest; debtor’s contact and phone number; nature of your business; details of any dispute and creditor’s response with copies of memos and correspondence. Additionally, they will provide the attorney with any documentation they have including: credit agreement; contracts, leases, personal guarantees, promissory notes, and NSF checks; purchase orders, delivery receipts, invoices, and statements of account; etc. The attorney will use this information during the legal demand process to try to bring the debtor to the table as well as use to substantiate their pleadings if suit is filed.

If the attorney has exhausted all their demands with no positive result, the next step is to consider a lawsuit. Before bringing a lawsuit, you want to be very sure that you have a good chance of winning. It is going to cost you some upfront money to file a lawsuit, and it would be silly to spend it if the debtor is out of business and you have no personal guarantee or if it is a highly contested debt and debtor has a good chance of successfully defending it. If you are going to file a lawsuit, you need to determine whether any of the following debtor defenses are possible:

• Could the debtor claim a prior payment?
• Is the amount due an offset?
• Does the debtor have a basis for a counterclaim?
• Is the debtor disputing the balance and has documentation to back it up?
• Is payment barred by the statute of limitations?
• Were the goods and/or services provided deemed inferior by the debtor?

If any of these defenses, and there are more, is possible then you may want to think twice before filing a lawsuit, because if you have to go to court the suit may become expensive, and there is a chance you might lose, thereby increasing your cost with no reward. Also remember, having a personal guarantee always helps. Furthermore, if a defense is expected, can you supply a witness at trial? Keep in mind the expense of travel as well as time your witness may need to be deposed or attend and testify at trial.

Many times a lawsuit will bring your debtor to the table to negotiate a payout or settlement. Also, keep in mind that at any time during the process, the debtor can file bankruptcy, which will immediately halt any legal proceedings or they can simply go out of business.

COURT COSTS AND FEES

Your agency will provide you with the attorney’s contingent fee requirement as well as any non-contingent fee requirement.

Court Costs

Filing a lawsuit costs money. Included in the suit costs will be:

• The cost of filing a summons and complaint

• The cost of serving the debtor

• Costs for various required attorney actions during the course of the lawsuit.

The attorney will require, in advance, their estimated costs for filing a suit and obtaining a judgment. The amount required will vary based upon jurisdiction and the venue where the lawsuit is filed. In addition, these fees are not negotiable as these costs are set by the courts.

These costs, however, most times are non-contingent and may not be lost. If you win, the court costs in connection with the lawsuit may be recovered from the debtor and you are entitled to a full return of the costs advanced if the debtor is required to pay costs as part of the judgment. .

Attorney Suit Fees

Essentially, these fall into two classes –contingent and non-contingent. Contingent suite fees, i.e., a fee based on the amount of the account as well as the amount collected. In addition to the contingency fees already applied to any monies collected, suit fees may also be charged. In essence, the suit fee is an additional fee the attorney earns for filing suit, no matter if you are successful in collecting.

The attorney may require a non-contingent fee to handle the case. This is a portion of the fee which attorney will earn upon the filing of suit. The non-contingent suit fees be applied towards the total suit fee the attorney earns which normally does not exceed a total of 10%.

HOW LONG WILL THE AVERAGE CASE TAKE?

If everything goes the attorney’s way and you get a default or no acceptable defense judgment, you can figure on six to nine months. However, every case is different and if the debtor puts up a fight it could take several years before a resolution is reached. The “wheels of justice move slowly” and creditors right litigation is no different.

COLLECTING A JUDGMENT

You have won your case and received a judgement from the court against your former customer, now all you have to do is collect the money due. If the debtor is located in the jurisdiction that the suit was filed then garnishments, marshal/sheriff levies, i.e., direct action against the debtor is possible. However, collecting a judgement can be a complicated matter. The lawsuit should always be filed in the jurisdiction where the debtors and their assets are located. Using a national agency that has the experience as well as database of local attorneys who specialize in collection litigation is a plus. A national collection agency has highly trained staff members who are familiar with the various laws of each state and their expertise affords them the opportunity to “quarterback” your attorney. Their goal is the same as yours, to conclude the matter as quickly and professionally as possible and maximize the money that is recovered. Some of the benefits of using your agency to handle your lawsuits:

• The agency can employ local attorneys who are bonded and insured to move the case as quickly and expeditiously as the local courts will allow.

• The agency can act as an effective conduit between you and the local attorney, thereby collecting the maximum amount in the shortest possible time while protecting your interests.

• The agency has more expertise, in collecting debtor judgments, in terms of volume of accounts and trained and available staff than any law firm. It is their business and their only business.

CONCLUSION

In the event that an account that you submit to your collection agency winds up with an attorney for litigation, before filing a lawsuit, carefully evaluate your chances of winning before you throw good money after bad. However, many times a lawsuit is your best and only chance of collecting.
Sam Fensterstock is Senior Vice President, Business Development, for AGA, a leading commercial collection agency based in Melville, NY. He can be reached at (631) 425-8800 or samf@agaltd.com.

Commercial Bankruptcy Filings Climb 29 Percent for the First Half of 2016

According to the American Bankruptcy Institute (ABI) data that was provided by Epiq Systems Inc. , total commercial filings during the first six months of the year (Jan. 1-June 30) increased 29 percent to 19,470 over the 15,071 total commercial filings during the same period in 2015. Commercial Chapter 11 filings also rose during the first half of 2016 as the 3,220 filings represented a 25 percent increase over the 2,575 commercial chapter 11 filings during the first six months of 2015.

“Data like this underscores the importance of regularly attending Industry Credit Group meetings and keeping up on alerts and RFIs on anscers,” said CMA President and CEO Mike Mitchell. “Our members have identified the trouble signs of companies big and small and have taken steps to regularly discuss troubled or slow-paying customers and have repeatedly had the upper hand on some of these accounts months before they filed.”

Fortunately, the members of one of our industry trade groups saw some warning signs several months ago and took action. They made this account a permanent one for meeting review, meaning it showed up as an RFI every month automatically. They monitored newspaper stories and internet reports and had their group facilitator distribute. They made it a regular account clearance on all conference calls, shared any information they received and individually took action to reduce their company’s exposure. A conservative estimate shows them being 3-5 months ahead in identifying trends than non-members.

“The business insolvency world has been slow for awhile, with sporadic, larger bankruptcies affecting our members,” said Molly Froschauer, general manager of CMA’s Adjustment Bureau, which provides innovative alternative solutions to creditors and distressed businesses. “At CMA Adjustments, we’re seeing business pick up but don’t yet know if the historically slow bankruptcy numbers are going to return to the normal level or if it’s a market blip. As we see businesses shutting their doors, our members’ rights should be protected and, whether it’s to put you in touch with an experienced bankruptcy attorney or to give you simple advice, we’re here for our members and to offer guidance should businesses begin to file many more bankruptcies.”

For more information on the study, click here.

Goodbye to Another Old Friend, by Larry Convoy

It seems that each month, a different industry feels the pain of losing one or more of their big players. It started in the Electronics industry a few years with Circuit City, moved over to the Grocery chains, department stores and last month it hit the Sporting Goods industry with 2 majors closing their doors. Besides having an impact on those who are losing their jobs, the amount of revenue these Big Box dealers generated may have been the only thing keeping some manufacturers profitable.

Fortunately, the members of one of our industry trade groups saw some warning signs several months ago and took action. They made this account a permanent one for meeting review, meaning it showed up as an RFI every month automatically. They monitored newspaper stories and internet reports and had their group facilitator distribute. They made it a regular account clearance on all conference calls, shared any information they received and individually took action to reduce their company’s exposure. A conservative estimate shows them being 3-5 months ahead in identifying trends than non-members.

As a result, they are in a better position to absorb any potential loss, certainly in a better position than some non-group members who have large exposures because they were not involved in the discussions over the last several months.

Many times when we approach a potential group member, their response is: “I only extend credit to Fortune 500 companies.” I am sure that those dealing with A&P, Haggens Food, Circuit City, Sport Chalet, Sports Authority, Blockbuster, Borders and Radio Shack to name a few all felt that they had a good handle on it.

We congratulate our industry group that identified a potential problem and took steps early to reduce their pain. The small financial investment they made in joining and participating in a group has paid off handsomely.

As we start a new “group year” with our new fiscal year beginning May 1, we encourage you to use all the tools CMA has to make sure you have the most current information on your customers, large and small.

Thanks for reading!

Why Out-of-Court Insolvency Pays Off, by Molly Froschauer

When facing a company showing signs of distress, we often hear credit managers afraid of the “big B,” bankruptcy. Well, while closing the doors of a company is never a pleasant thing, there might be another way to shut down without the many legal pitfalls for creditors in bankruptcy. The legal world fully embraces any sort of out-of-court resolution, with mediation and arbitration being considered preferable to courtroom solutions. In the business world, contracts often have an arbitration decision or disputes are resolved in mediation. Employing any alternative dispute resolution has many advantages, and mirror those provided by the business insolvency services at CMA.

Handling issues out of court is less expensive, less time-consuming, and considerably more private. The same can be said about the assignment (“ABC”) process, but ABCs are still a relatively little-known alternative to business bankruptcies. Normally, a business that has decided to close its doors would consult with an attorney to either wind down operations with legal advice from corporate counsel, or, it would file a Chapter 7.

The decision to file the Chapter 7 is complicated and should be taken with care and advice of counsel. However, if attaining finality for the closure of the business is the goal, an out-of-court option is available. Assignments for the benefit of creditors have all of the same advantages of alternative dispute resolution but in a bankruptcy context. For example, instead of obtaining judge approval to dispose of assets, CMA, as assignee can handle immediately. Also, as actions are not handled on a public docket, it’s a less visible process. As assignment can be done very quickly as well, creating a feeling of closure for everyone involved.

Alternatives to bankruptcy offer the same benefits as those in litigation and should be an important part of the legal landscape in the future. It’s important, when winding down, to know all options. Every situation is treated differently and the team at CMA can be very flexible with the specifics of any business. The easiest way to determine whether the alternatives discussed here are right for you is to call CMA. We appreciate the uniqueness of each business and are happy to discuss the particularities in detail.

Molly Froschauer is CMA’s Insolvency Services Manager. A bankruptcy attorney licensed to practice in California, she can be reached at 818-972-5315.

Do You Know of a Company On the Verge of Bankruptcy?

Working in conjunction with the business and its creditors, CMA provides a struggling business with the opportunity to re-establish its financial credibility through time and planning, or to assist in ceasing its existence while minimizing losses to its creditors. As an efficient bankruptcy alternative, CMA provides all of the services necessary to wind down operations of a distressed business while avoiding both the administrative expense and paperwork associated with bankruptcy court. These alternatives are often less cumbersome for all involved and are less expensive, which means more return to creditors and more money left in the business to regain its footing.

If you know of a struggling company looking for bankruptcy alternatives, refer them to:

CMA Adjustments
Expertise in: Bankruptcy, Preferences, Reclamation, Proof of Claims, Creditor Committee, Chapter 7, Chapter  11,  Bankruptcy Alternatives
Phone: 800-541-2622

www.CMAAdjustments.com

Not The Top Ten List You Want To Be On, by Larry Convoy

With due respect to David Letterman and Sports Center’s nightly “Top 10” lists, there are some lists that you would be better off not being on.  One that directly affects you and your company is “The Top 20 Creditors in a Bankruptcy Case,” a document that is easily obtainable by accessing Pacer. No company likes to see their losses published for all to see.

CMA Industry Group Leader Larry Convoy
CMA Industry Group Leader Larry Convoy

However, this document of doom will now be turned into an excellent prospect list for any industry credit group (ICG). Whenever you post an alert of a Chapter 11 in your industry, CMA will run a list of the top 20 creditors. These companies could be competitors of yours, or they are at least selling into the same market as you and have just taken what could be a major hit. A phone call from a group member informing them about the group, and mentioning that the group was aware of the problem and therefore had minimal exposure, could get the group a new member very easily.

Therefore, effective with the next Chapter 11 alert posted on anscers, the ICG department will forward this list of names to the group chairmen and group facilitator. There will probably be some banks, factors or lending companies that would not fit but you should be able to identify some HOT prospects. Tell them that the best way to avoid the next BK is through membership in your credit group.

Thank you for your support throughout 2014, and we wish you and your family a Happy and Healthy Holiday Season and a Prosperous 2015.

Larry Convoy
Lead Group Facilitator
lconvoy@emailcma.org

Give and Take; Trying to Find the Right Balance – Michael Dennis, CBF

Give & Take

First and foremost, I am very grateful for the work done by official unsecured Creditors Committees in Chapter 11 bankruptcies.  Having served on two Committees, in my opinion what members of the committee give to the creditor community is far more than they are likely to take from serving on a Committee.

A former student of mine called recently about serving on a Creditors Committee.  She explained that she was asked to serve, and believed joining a Committee would provide her with insights about why some customers file for bankruptcy protection.  Her plan was to use these insights to help her to avoid bad debt write offs in the future.

I responded that I did not recall a time when a Committee that I served focused on what went wrong in the debtor company.  Why?  We were too busy monitoring the debtor’s progress, or commenting on the proposed Plan of Reorganization, and discussing preferential transfers among many other tasks.  I told her that Committee membership requires a significant and lengthy time commitment.  I cautioned her that her own work would probably pile up while she attended offsite meetings or participated in lengthy conference calls with other Committee members and legal counsel.

Recognizing her goal was to become better at spotting customers in financial trouble, I suggested that she consider continuing her professional development by preparing for and taking the CCE Exam as an alternative to serving on the

Michael Dennis, CBF

Committee.  I am not sure whether she took my advice, but I am sure I will find out when she reads this Blog.

What are your thoughts?  Was my advice ‘on the mark’ or way off base?  Comments and constructive criticism is always welcomed.

Michael Dennis’ Covering Credit Commentary. Michael’s website is  www.coveringcredit.com

The opinions presented are those of the author.  The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors.  Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.

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Don’t Get Stuck Between a Rock and a Hard Place – Michael Dennis, CBF

Don't Get Stuck

Sooner or later, every credit professional will be asked this question by their boss: “What credit limit do you recommend we assign to this customer or applicant — the one with the deficit net worth?”

Customers with a deficit net worth are technically insolvent, and insolvent companies have a nasty habit of filing for bankruptcy protection. There is no good or right answer to this question. The answer depends on your company’s tolerance for credit risk. However, the fact that your manager is asking you for a recommendation suggests that s/he believes the customer should be given open account terms at some dollar level.

I use one of two approaches to address this problem. The first involves rephrasing the question this way: “If you are asking how much credit I would extend to a company that is technically bankrupt, the answer is that I would not recommend open account terms.” This response is honest and direct, and makes your position crystal clear.

The other approach involves explaining that your experience does not provide you with any guidelines relating to recommending credit limits for customers with a deficit net worth, and that you would appreciate their help. Ask for their guidance about what process they would use to determine how much money your company is willing to risk on this type of customer. Done correctly, this can become a useful training tool for the credit decision-maker.

Both approaches might cause your manager to question your willingness to make tough decisions. The good news is that you may be able to avoid the problem altogether by updating your Policies and Procedures Manual. If you develop a Credit Policy that addresses who has the authority to extend credit to the highest risk companies, and what facts and factors that credit decision will be based on, you can avoid being caught between a rock and a hard place.

Michael Dennis, CBF

I am always interested in hearing your opinions. Please let me know how you have handled this challenge effectively.

Michael Dennis’ Covering Credit Commentary. Michael’s website is  www.coveringcredit.com

The opinions presented are those of the author.  The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors.  Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.

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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.”

Protecting Profit in Anticipation of Bankruptcy

“We seem to have a crisis a week and now the crisis is the risk of bankruptcy of the big three auto companies,” said Bruce Nathan, partner at Lowenstein Sandler PC. “There’s lots of turmoil, credit is gone as a result of the Lehman Brothers filing, the credit markets are pretty much dried up. There is no funding that’s available to restructure a lot of these distressed companies and this has led to a large increase in bankruptcy filings.”

In short, Nathan illustrated that when it comes to trade creditors looking to protect their company’s profit from insolvent customers, a teleconference such as his couldn’t have come soon enough. “This teleconference could not have been scheduled at a more appropriate time because we’re trying to protect ourselves,” he said.

Attendees got a chance to bask in Nathan’s always-enthusiastic expertise regarding the ways creditors can protect themselves in the case of a customer’s bankruptcy. First, Nathan noted, it’s important that creditors know where they can get information pertaining to their case. “There’s a lot of public information out there to see if your customer is financially distressed,” he said, adding that, in some instances, this information could easily be used to predict a customer’s future. “There’s a lot of information that you could be looking at that could predict bankruptcy a year from now. Whether it’s ratings, information you could get from your credit group, a credit check, these publications will predict the bankruptcy a year or two before the actual bankruptcy.”

By leveraging this information and spotting any troubled company warning signs, credit professionals can make sure they act soon enough to protect their company’s investment in a customer, ensuring their payment long before receiving a word of a bankruptcy filing. “The warning signals that you should be looking at, once you get them, should prompt you to take action to protect yourself and try to obtain some sort of security,” said Nathan, who used the majority of his presentation discussing the many ways creditor companies can secure their investments prior to customer filing, including their advantages, disadvantages and legal requisites. “These credit enhancements increase the likelihood of you being paid on your claim when you have a customer who is on the path to bankruptcy, but not there yet.”

Nathan went into detail about credit enhancements like letters of credit, security interests, guaranties, put agreements and many more.

The Risks and Rewards of Selling Your Bankruptcy Claim

Concern over whether a customer is having financial problems has always been a central issue for credit managers. Their role is defined by being able to pick which companies are worth the risk. With bankruptcy filings rising, default and delinquency rates also trending upwards, its the issue of insolvency that’s getting the spotlight at the moment.

Even worse for credit departments is the customer on the verge of filing a Chapter 11 petition. These creditors face the risk of a decrease in or a substantial delay to the recovery of their pre-petition unsecured trade claim. Not to mention the additional risk of continuing to extend credit to the customer. 

But there are options. Creditors can gamble by selling their pre-petition unsecured claim or by entering into a put agreement that shifts the credit risk of dealing with a financially distressed company to a third party. Debt markets continue to flourish and over the last two decades have evolved tremendously with the amount of public information available through the Internet and services like PACER, providing an educated seller or buyer with a sizeable advantage. 

“It all sounds wonderful. And the market allows trade creditors to cash out of their claim,” said Bruce Nathan, Esq., partner, Lowenstein Sandler PC. “But, when you get that offer to buy the bankruptcy claim you’ve got to tread carefully. You’ve got to do your homework and make sure you’re getting the best price.”

Nathan talked about two options available to credit managers in the CMA-sponsored teleconference “Selling Your Bankruptcy Claim—the Risks and Rewards.” First, there are buyers that will purchase a put agreement—a product equivalent to credit insurance—for a trade creditor’s claim in the event of their customer’s bankruptcy filing. 

A put agreement is an agreement for the buyer to purchase the claim in the future at an agreed-upon price. It’s used as protection against insolvency. They require the creditor that is entering into the put agreement with the buyer to pay a non-refundable fee, which could be as much as 1% to 3% per month of the amount being insured. They can be for a claim against a financially distressed company that has not filed bankruptcy yet, or they can be for an administrative claim where the creditor has sold goods or provided services to a company that is in Chapter 11.

“They are two very different products,” explained Nathan. “There are more pitfalls for a put with respect to a Chapter 11 administrative claim if it is not drafted appropriately, but the benefit of a put agreement is that it induces creditors to continue to extend credit to a financially troubled company, whether that company is in or out of bankruptcy.”

The difference between a put agreement and credit insurance is the credit insurance usually involves insuring a pool of receivables—good receivables and the more troubled accounts. Put agreements are insuring against the insolvency of a particular company that is in financial distress. Because of this, puts can be a lot more expensive than credit insurance.

“If you’re paying a hefty fee, you want to make sure you are getting the best for your bargain,” said Nathan. 

As in all contractual environments, signers need to be wary. Some agreements may contain objectionable provisions that are intended to shift the risk off of a bad investment from the buyer back to the seller. Others may allow the buyer, in circumstances of their choosing, to force the seller to buy the claim back because of some breach of agreement. Nathan warned that there are many outs in these agreements a good claims buyer can take advantage of if they decided they no longer want to invest in the claim, or they found out information after the fact. So, the standard mantra applies: credit managers must review the documentation that they are being asked to sign. 

“The key is that if you are an informed buyer, or an informed seller, and you know what needs to be changed and what needs to be negotiated, with the help of counsel you can have an agreement that works really well for you,” said Nathan. “One that allows you to liquidate your claim and to insure yourself against the risk of bankruptcy. But if you carelessly sign on the dotted line, you may find that while you sold the claim and realized some cash, or what you thought may have required a buyer to buy the claim in the event of a bankruptcy, you find out that there are lots of horrors and lots of outs.”

Another option available for creditors is selling their claim against a financially distressed company to a prospective buyer. In cases of puts or a sale of claim, there is typically a discount in price if the company is already involved in a bankruptcy. In both products, there are a number of matters to be considered, as well as a cadre of pitfalls to avoid.

“When you are negotiating a put agreement, or for that matter a sale of claim agreement, you need to make sure that the debtor—the customer—is properly identified,” warned Nathan. “In more and more cases, you are dealing with multiple entities where there may be lots of different companies that make up the debtor.”

Construction Industry – Pitfalls to Avoid

For the most part, the construction industry is struggling through lean times. According to the U.S. Department of Commerce’s U.S. Census Bureau report for May, for the first five months of 2008, construction spending totaled $416.6 billion, 5.1% below the total for the same period last year. Residential construction spending continues to
topple, dipping to $378.9 billion in May, 1.6% below April and 26.9% below May 2007. Private construction spending as a whole has shed almost 10% year-over-year.
With standards remaining tight in the credit markets, the impacts are being felt the length of the value chain. There is a trickle-down effect from the creditors to developers, from the developers to the builders—who are sitting on a
large inventory of homes—and from the builders down to the subcontractors. In his CMA-sponsored teleconference “Pitfalls to Avoid in Being a Subcontractor on a Construction Site,” Byron Saintsing, partner, Smith Debnam Narron Wyche Saintsing & Myers, LLP, shared a wide range of information from lien claims and payment bonds to
bankruptcy issues to help subcontractors and other construction site partners keep their heads above water during difficult times.

“The market out there today, at least on the residential side, is in pretty bad shape and I think everyone knows that,” said Saintsing. “If you are dealing with and are selling to a subcontractor that’s on the residential side of the market, chances are that they have hit some bumps in the road and if they haven’t, they’re going to.”

First and foremost, Saintsing suggested maintaining high credit standards. There is often pressure from the sales department when sales are down to ask credit departments to cut corners, extend terms, create special terms and simply relax standards across the board, but from the credit managers’ perspective, this is the time to remain firm.

“Now is not the time to loosen your credit standards,” stated Saintsing. “If you do, I’m afraid you’ll see your bad debt write-offs continue to go up, not down.”

Saintsing recommended that credit professionals examine their documentation and make sure contracts are
being properly executed. If they are taking collateral, they want to take a look at things like proof of delivery, verification of where that collateral is and they want to make sure that their UCC-1 financing statements are properly filed. Customers need to be examined to determine what kind of ability they have to repay the credit that’s being extended to them. Due diligence needs to be practiced with credit and trade references, as well as with financial statements and credit reports.

“You want to take extra precautions in this environment to verify who your customers are and what kind of entity
they are,” explained Saintsing. “You really do need to know on the front end who you are dealing with and what their ability to pay is. The time to ask those questions is not on the back end when you have a payment problem.”

There are legal avenues available if payment problems do occur. For example, if a bankruptcy has been
filed, or imminent, credit managers are eligible for reclamation rights under the Uniform Commercial Code. Non-bankruptcy law reclamation rights state that creditors have 10 days after their customers received
goods of sale to give notice of reclamation if the customer was insolvent when they received them.

“That’s not very much time, so reclamation rights, in the real world, are hard to assert,” said Saintsing. “It’s easy for a lawyer like me to say, ‘Sure, go file a reclamation notice.’ But in the real world, not many people are paying within 10 days, so it makes it tough to use reclamation rights. But they are available.”

Of course, mechanic’s liens on private projects and payment bonds on public projects are courses of action as well. But because statutes vary from state to state, credit departments need to have resources that specify all the nuances to ensure they are eligible to recover what’s due to them. CMA has tools to give detailed information on each state’s procedures and policies.

 

Bankruptcy Point/Counterpoint Discussion

Two of CMA’s most popular legal minds went head-to-head during the recent “Bankruptcy Update: Point/Counterpoint” teleconference, where they discussed several BAPCPA protections for trade creditors, along with the most current related case law and the administrative ambiguities that accompany some creditor
defenses. Bruce Nathan, Esq. of Lowenstein Sandler PC acted as the voice of the courts, while Wanda Borges, Esq. of Borges & Associates LLC acted as the voice of the trade creditor.

Several topics were discussed throughout the program, most notably the 503(b)(9) 20-day administrative claim and the increasing use of executory contracts among trade creditors. Speaking about the 20-day administrative claim,
Nathan noted, “This is one of the biggest amendments of the BAPCPA,” adding, “This has become a safety net for suppliers.” He then discussed how trade creditors have to go about getting the actual claim. “This 20-day priority is
not automatic,” he said. “The Bankruptcy Code requires that this priority be granted after a notice and a hearing.”

Problems arise with the 20-day administrative claim in terms of when the claim is actually supposed to be paid. “There’s nothing in the statute that talks about when this claim is paid,” said Nathan, noting that payment times
differ from district to district. “It’s the court that makes the decision.”

Borges responded with her opinion of when the claim should technically be paid. “The Code is silent, but I think it should be paid now and should be paid in full,” she said, offering advice to trade creditors when filing this claim.
“You’ve got to move, you’ve got to move fast, and you’ve got to move furious.”

Later, Borges discussed her own personal experiences with executory contracts and their idiosyncrasies. “In the last six months, I have seen more issues with executory contracts with my clients and with trade creditors,” she said. “It’s effectively a contract where something has to be done on both sides. In order to have a Chapter 11 debtor agree to stay in the executory contract, the debtor has to pay, in full, all arrearages or provide adequate insurance that you’re going to get paid.” After hearing that, trade creditors might find the prospect of an executory contract quite alluring, but Borges and Nathan discussed the other issues and prerequisites that complicate the issue.

Other topics discussed included preferences, changes in the ordinary course of business defense and issues associated with the contemporaneous exchange for new value defense.

Structuring LCs to Protect Your Company

“The letter of credit (LC) is an obligation that banks have to your company if certain conditions set forth in the LC are met,” said Robert Mercer, Esq. of law firm Powell Goldstein, LLP. “This is an attempt to isolate your company from the customer.”

Mercer, a partner at Powell Goldstein’s Atlanta office who practices in its Bankruptcy & Financial Restructuring Group, discussed LCs and the best ways to structure them at a recent CMA webinar entitled “Structuring Letters of Credit That Won’t Leave You Stranded in a Customer Bankruptcy.” Over the course of his presentation, Mercer outlined common stipulations that creditors should include as well as some that they should avoid when drafting their LCs.

Most importantly, Mercer noted, a vendor using an LC should be sure to include a Bankruptcy trigger in the LC, rather than just in the supply contract. Since the revisions made to the bankruptcy Code in the 1970s, provisions in contracts that attempt to construe a customer bankruptcy as a form of default have been unenforceable, meaning that when a customer files, the vendor is left open to preferences and placed in the running with the rest of the customer’s unsecured creditors. Still, these provisions are used very frequently. “You see them in many commercial documents,” said Mercer. “Put in the LC that, if the customer files bankruptcy, it’s a basis under which your company can draw on the LC.” In this way, when a customer files bankruptcy, under the terms of the LC, the bank is still obligated to pay your company.

“This is a really simple fix,” he added. “That’s a provision you want in the LC.”

Mercer also discussed the importance of removing as many conditions as possible from the LC, including provisions that require a vendor to give a bank or the customer a few days notice before drawing on the LC or provisions that
require the vendor to seek consent before drawing.

 

How Bankruptcy Came Back to Bite a Company with Loose Lips…

Section 548, the fraudulent transfer portion of the Bankruptcy Code, is placing more emphasis on the importance of what is said. The law firm of Powell Goldstein, LLP highlighted two recent bankruptcy cases where loose lips from defendants came back to bite them.

In the recent bankruptcy hearing for Teligent Inc. in New York, the former CEO and chairman had in his employment agreement that a $15 million loan would be forgiven only if he left the company for “good reason” or was terminated other than “for cause.” The company switched hands several years after the agreement was signed and the CEO decided to part ways. He filed a separation agreement which reasserted that the loan would be forgiven and was terminated other than “for cause.” The trustee sued the CEO under section 548, alleging any forgiveness of the loan would constitute fraud. The reason being: at the time of his departure the CEO gave an interview to a local newspaper and was quoted in the article as saying he was dissatisfied with the new owners and wanted to explore new opportunities. The court found this evidence persuasive and voided the release, which deemed him liable for the loan. According to Powell Goldstein, if the CEO had simply declined to comment as to the reasons for his
departure, the outcome would have been different. The law firm remained that “a release can constitute a transfer under section 548.”

The second case Powell Goldstein highlighted involved Student Financing Corp. (SFC), which approached SWH Funding Corp.—the two having had a long-term relationship—for an $80 million loan. There was an application fee of $400,000 required by SWH. A little while later, SFC changed its mind and backed out, only to come back after a couple weeks to re-pursue the loan. SWH charged an additional $250,000 application fee. In the end, the loan was denied. During SFC’s bankruptcy case, the trustee sued SWH for the $650,000 on the grounds that the lender was attempting to hinder, delay and defraud creditors.

The trustee’s case relied on an email written by SWH’s president to SFC’s attorney that said, “No joke, you know from the last SFC deal we have no money. We were just using the old ‘the documents aren’t done’ to get out of financing.” SWH’s president said that the remark was supposed to be sarcastic, and of course, the bankruptcy case disagreed. Powell Goldstein reminded that, “the moral of the story is to write emails cautiously.”

How Setoff and Recoupment are Hidden Gold for Trade Creditors

When dealing with an insolvent or bankrupt debtor, creditors will do everything in their power to reclaim the money they were owed. Whether securing transactions prior to sale or using specific legal defenses in the courtroom,
every credit manager can get hit by a debtor who won’t or can’t pay, so it’s best to have as many tools available as possible to better protect a company’s assets. Two of the most overlooked options that creditors can use to get back
part of what they’re owed are setoff and recoupment.

“What I find interesting in all of these conversations is the lack of knowledge that creditors have of this right,” said Bruce Nathan, Esq. in a recent CMA-sponsored webinar entitled “Setoff and Recoupment: Hidden Gold for Trade Creditors.” Nathan noted that setoff, although not explicitly listed in the Bankruptcy Code, is a state law right that is viewed as a self-help measure that creditors can use whenever they’d like. It can be used when a creditor and debtor are doing business with one another and owe each other money. It makes little sense to pay a debt when the payee owes the payor money, so setoff allows both parties to reduce their obligations to one another by setting off one claim against another.

There are, however, legal requirements that need to be satisfied for creditors to use setoff, and, in his presentation, Nathan discussed these, making certain that attendees knew how to avoid any legal missteps that might preclude any successful setoff. Nathan also noted that after a debtor has filed for bankruptcy, setoff needs court approval before it can be used. “Once a debtor files for bankruptcy, setoff rights are restricted,” said Nathan. “The automatic stay arising under Section 362 of the Bankruptcy Code would prevent a creditor from unilaterally exercising setoff rights.” Nathan also noted several other legal hoops that creditors have to jump through prior to successfully
reducing their claim using setoff, whether before or after a bankruptcy filing.

Recoupment, said Nathan, is very similar to setoff but with one important difference. “All that is required for recoupment to take place is that it arises from a single claim or transaction,” he said. “Recoupment is essentially a
defense to a debtor’s claim against a creditor.” Nathan also noted that recoupment is a slight improvement over setoff, because it is not governed by the automatic stay rule and does not require a creditor to get the permission of
the court to exercise the right.

How to Better Prepare Against Preferences

Preferences can be a daunting challenge for creditors but Bruce Nathan, Esq., of Lowenstein Sandler PC of New York, presented information on how to better defend against them. The information was disseminated during a CMA webinar Feb. 12, 2007 entitled, “Preferences: Defenses That Can Reduce Exposure and Case Law Update.”

Nathan, a private attorney who specializes in bankruptcy law, noted the large amount of case law on preferences over the last year, and noted how bankruptcy cases are now making their way to court under the authority of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). One big change under BAPCPA cited by Nathan was that the “ordinary course of business” defense against preferences is more advantageous to creditors. In defining a preference, Nathan said that generally it is a transfer of property of the debtor to or for the benefit of the creditor on account of existing debt owed by the debtor before the transfer was made. Furthermore, to be a preference, the transfer has to be made while the debtor is insolvent, it must have been made within 90 days before filing of the bankruptcy petition and the transfer must enable the creditor to receive more than he would receive in a liquidation.

Defenses to preferences are found in section 547(c) of the Bankruptcy Code, Nathan said. He pointed out that generally no preferences are applied to COD payments. Also, creditors can rebut the presumption of insolvency that is afforded debtors within 90 days of a bankruptcy filing, although that may be difficult to prove. “If you have financial statements that show a company (filing bankruptcy) was solvent close to that 90-day period of presumption of insolvency, you may make a case,” Nathan said. “A court, in determining insolvency, may include assets and liabilities that aren’t on a balance sheet.” Nathan also noted that those creditors defined as insiders, are exposed to a longer preference period of one year. Nathan advised creditors who receive preference claims to review their payments from that debtor within the last 90 days prior to the filing of the bankruptcy. He pointed out that some trustees just look at the check register of the debtor and send out preference demand letters to those creditors listed on the debtor’s check register during that 90-day period. However, while a payment may have been listed on a debtor’s check register, the creditor may not have received it. On the extemporaneous exchange of a product, which is new value, for payment, as in COD transactions, Nathan warned that if the check bounces and is replaced, the replacement of the check is considered an extension of credit. In that case, a preference claim could be made on that transaction. He also said, “The COD claim is only for goods that are exchanged for payment, not for the payment of old invoices.”

The ordinary course of business defense against preference claims has now become easier under BAPCPA Nathan said. “Under the old statute, there were a number of things that could cause the loss of the ordinary course of business defense.” Under the old law, a creditor had to prove a payment was made in the ordinary course of business with that customer and within the industry. He noted that if a creditor was doing business for the first time with a customer, there would be no payment history to establish an ordinary course of business with that customer. “Some courts would say the first transaction couldn’t be viewed as ordinary course of business.” Now creditors have to show that a payment was ordinary between that creditor and customer or that it was ordinary for the industry.

One of the attendees of the teleconference asked Nathan if trustees couldn’t be sanctioned for merely sending out preference demand letters from a debtor’s check register. “This is an abuse and it’s unfortunate,” Nathan said. “There are some circumstances where sanctions can be assessed. There are a few judges that have ruled that with obvious defenses, abuses have been committed.” However, he noted that it is difficult to have a judge sanction a trustee regarding sending out preference claims. “A judge would only sanction if you went to trial and won.” Another attendee asked a question about preference claims having to be related to a payment in the amount of $5,000 or more and whether that amount refers to individual payments or total payments? Nathan answered that it refers to lump sum and not each individual payment from a debtor.