Important Initial Considerations When a Customer or Vendor Files Bankruptcy

11/08/2010 / L. Kathleen Harrell-Latham and Mark R. Geier

The current economic climate has led to an increasing number of bankruptcy filings. This article summarizes some important strategic considerations and initial steps that can be taken upon learning of such a filing by your customer or vendor in order to help minimize risks while maximizing your potential return in the bankruptcy. 
Prompt Action and Verification of Bankruptcy
The first thing to do upon learning of a bankruptcy filing is to review the contract. Contract review helps to verify all of the entities that may be liable for the indebtedness which may include an entity not in bankruptcy. This review may also show that the party liable for the receivable did not actually file for bankruptcy, but that it was instead an affiliate or related entity. If the entity listed on the contract did not actually file bankruptcy, then you may proceed with your typical protocols for collection of the full balance.
The next step is to verify that a bankruptcy has actually been filed and to obtain information on the particular bankruptcy case. The most important piece of initial information to obtain is what type of bankruptcy has been filed.  A Chapter 11 filing generally means that the entity will stay in operations and may continue to either purchase or supply goods. Alternatively, a Chapter 7 bankruptcy means that the operations will or have terminated and that a court appointed trustee will liquidate remaining assets. If possible, also try to obtain copies of any documents that have been filed with the bankruptcy court to learn what has already happened and to identify any upcoming deadlines. A number of documents are mailed to most creditors in the case. Copies of all documents filed with the court can also be obtained by your attorney who should be able to access them from the court’s website for a relatively small fee.
Take Steps to Avoid a Violation of the Automatic Stay
The next step to take upon learning of a bankruptcy is to inform all of the internal people involved in the particular account. Information sharing will help to avoid an inadvertent violation of the bankruptcy code’s automatic protection of entities in bankruptcy from collection actions. A violation of the automatic stay could result in the assessment of damages which may also include attorneys’ fees. However, depending upon the terms of your contract, it may still be possible to switch a customer to a COD basis or to otherwise terminate deliveries. Given the high costs of a potential violation, it is advisable to consult with an attorney before implementing any changes in the relationship with an entity in bankruptcy. An attorney may also be able to obtain a modification or removal of the automatic stay for things such as the retrieval of your goods or even proceeding with a pending suit outside of bankruptcy.
Reclamation of Goods
The Bankruptcy Code also provides a mechanism for sellers to reclaim goods shipped to an insolvent buyer. This is only applicable where: (1) the property sought to be recovered is a good; (2) it was sold in the ordinary course of business; (3) buyer was insolvent when it took physical possession; and (4) a written demand for return of the goods was made within the brief allotted timeframe of buyer’s possession. The bankruptcy court may still deny this relief even if all of the elements are present. In that case, the court is required to either grant a lien securing the claim or an administrative priority expense. Accordingly, despite the short deadlines and potential costs, it is definitely worth undertaking the steps necessary to preserve this remedy.
File a Proof of Claim
Regardless of the type of bankruptcy, it is important to make sure that a proof of claim is timely filed with the bankruptcy court. An attorney is not necessary to prepare and file a claim and it is the best means to make sure that you will receive some kind of payment. The ability to amend, transfer, or sell a claim after it has been filed is also liberally permitted by bankruptcy courts. Therefore, where permissible, the better course of action is to file something even if the amount of claim at the time is unclear or contingent on some future event. 
Determine Your Level of Involvement in the Bankruptcy
It may be worth pursuing an appointment to the creditors’ committee depending upon the particular situation of the bankruptcy case and the amount of the receivable. One advantage to participating in the committee is that the bankruptcy debtor must pay for the attorney for the creditors’ committee. Another avenue for potential involvement in the case is to attend the meeting of creditors. The meeting of creditors is an informal hearing where any creditor may appear and ask questions of the debtor on the record. This can be an opportunity to learn valuable information about the debtor’s intention with your contract or even its plans for the case. Developing a strategy early and possibly consulting with an attorney is likely the best means to avoid missing any opportunity. 
Conclusion
The most important step to minimizing risk and maximizing return as a creditor in a bankruptcy case is to compile as much information as early as possible in order to preserve certain rights and to develop a strategy for the case. Then choose your path wisely, using an attorney as you deem appropriate. 
Mark Geier is an attorney in Larkin Hoffman’s corporate and mergers and acquisitions groups.