Considering Your Counterparty Filed Chapter 11? Check These 10 Boxes

  • September 22, 2022
  • admin
  • 14 min read

When faced with the Chapter 11 bankruptcy of important vendors, far too many suppliers choose to play a passive role. It makes sense given that bankruptcy may be complicated, extremely disruptive, and occasionally call for significant time and effort from in-house counsel. But with a little thought and a plan, a creditor can significantly enhance its outcome.

Assess the bankruptcy kind and what it entails first. The risks of losing a debtor’s business could be overwhelming and catastrophic, the law is frequently hazy and biased in favor of the debtor, and your power to influence the outcome may appear restricted. However, this complacent attitude can be badly hurting suppliers. If suppliers are given more care and certain protective measures, they may be able to recover their claims more quickly and reduce further losses in the event that the debtor tries to stop making some pre-petition payments to them. The 10 suggestions and reminders listed below might help suppliers start acting more proactively and enhance their results.

1. Observe the docket

Find out as soon as you can about the hazards of bankruptcy. Public papers made on the opening day of a bankruptcy case and during the case’s duration contain a wealth of helpful information. Do not wait for notices to be mailed and subsequently delivered to the employee who is in charge of the relationship at your organization. The docket (or schedule of all filings made in the case) is readily available through an easy online search, or in larger cases where a third-party noticing agent has been employed, a creditor or their attorney can file requests to get notice of all filings.

The first-day declaration, which is frequently presented by a member of the debtor’s executive team, possibly a chief restructuring officer hired to get the business ready for bankruptcy, is of particular significance. The debtor’s relevant history, the reasons for its financial crisis, and its anticipated road to reorganization are all highlighted in this declaration, which is frequently long. You might discover, for instance, that the company plans to sell its assets or, alternatively, to restructure its operations with a better capital structure. In addition to keeping an eye on the docket, inform the necessary team members that all correspondence regarding the case should be sent right away to a central location for evaluation.

2. Support the designation of important vendors

Debtors frequently ask for permission to provide their most important and strategic suppliers and vendors special treatment (or critical vendors in bankruptcy parlance). Debtors frequently make the claim that, in the absence of preferential treatment, some suppliers and vendors may stop doing business with them, harming the chances of a reorganization, based on the legal principle known as the doctrine of necessity. Historically, these important vendors were paid in full for their prepetition claims (while other unsecured creditors may be paid only pennies on the dollar).

In exchange for sustained performance, debtors have requested courts for more latitude regarding the timing and dollar amounts that they can give (for instance, payment of 50% of the creditor’s claim to be made 120 days from the filing date).

In some circumstances, important vendor orders are entered first. Be proactive and get in touch with your contacts for debtors as soon as you can. Keep a watchful eye out for any discretionary language in the order when it is entered as this will inform the creditor on the debtor’s flexibility to consider the vendor a critical one and to negotiate treatment. If this preferred class is not offered, creditors should push for inclusion in it and seek the best possible agreement, which may not be the one initially presented.

3. Review your agreements

Recognize the rights and responsibilities your business may have under any contracts or agreements you may have with your debtor counterparty. With very few exceptions, if these agreements are executory contracts—those where meaningful performance is still owed by both parties—the debtor may accept them or reject them at any point throughout the proceedings.

Depending on its business judgment, the debtor may decide to perform (assume) or reject executory contracts during the litigation. Contracts may also be transferred to a third party in connection with an assumption (despite otherwise legitimate anti-assignment terms) if specific requirements are met. If the debt is assumed, the debtor must remedy any monetary breaches (for instance, pay all unpaid claims in full) and give “sufficient assurance of future performance” that it or a third party assignee can fulfill the contract’s obligations (for example, prove that it has the financial wherewithal to perform). Any loose termination provisions will likewise remain, as assumption requires that the executory contract be assumed in the form in which it was at the time of assumption.

Be mindful that a debtor might threaten to reject a proposal in order to renegotiate specific terms. Any such threats should be taken seriously, but don’t put too much stock in partners at the debtor making them. In any such situation, a creditor will need to make a considered decision regarding the actual likelihood of rejection (as opposed to the threat of rejection) and the effects a rejection would have on its business. A unique opportunity to think about changes to form agreements for usage moving ahead will also be presented by this study. However, no provider should hold off on doing this review until a counterparty declares bankruptcy. Perform risk analyses before signing contracts.

4. Think about joining the creditors’ committee

In the majority of commercial cases, the US Trustee (a branch of the US Department of Justice) will appoint an official committee of unsecured creditors to represent the interests of all unsecured creditors. This committee will typically be made up of five to seven of the largest unsecured creditors. To represent its interests, the committee is permitted to hire legal counsel and financial experts, who are compensated by the debtor. If a creditor is not approached, it is unlikely that it will be a candidate for the committee because the US Trustee will actively seek out creditors’ participation.

If a creditor has any inquiries and decides that it does not intend to participate or is ineligible for the committee owing to the amount of its claim, it might think about contacting the committee’s appointed advisors. A creditor may think about creating an ad hoc committee of creditors with related interests if the interests of other unsecured creditors do not coincide with its own. If you can make a “significant contribution” to the case, you can ask that the debtor pay for the professional costs and expenditures of the unofficial committee in order to increase your influence over the way the plan is structured.

5. Recognize bar date orders and submit your claim promptly

The court will set the deadline for submitting general unsecured claims (also known as the bar date), which will appear on the docket whether the case is in its early or late stages. Additionally, a notice will be sent via US mail.

To prevent any mistakes, pay close attention to the instructions, prepare your claims, and submit them well before the deadline. The repercussions of failing to do so may be severe, and exceptions are only made under the stringent criterion of excusable negligence.

The claim, no matter how substantial, runs the risk of being permanently discharged if any late submission was under the creditor’s (or its attorney’s) control, such as a late filing because an attorney lacked the necessary credentials to file electronically. Keep careful track of comparable deadlines for the following two possible additional claim types: Administrative claims and 503(b)(9) claims (claims for goods received within 20 days of the case and frequently set early in the case) (claims for goods and services provided during the bankruptcy and often set at the tail end of the case). Both of the latter categories are eligible for full payment. Importantly, creditors must keep an eye out for any potential objections that might be submitted.

6. Know the debtor’s financial situation

If the debtor will need to employ cash collateral (cash in the company’s accounts) or to borrow more funds, debtor-in-possession (DIP) financing, operating during bankruptcy frequently requires court clearance.

DIP funding is typically offered by one or more of the debtor’s pre-bankruptcy lenders who are motivated to lend in order to protect the value of the company (and naturally, their collateral), preventing a value-eroding liquidation. Debtors request this approval in one of the several first day motions that are filed in almost every corporate case since they frequently depend on having access to cash. The priority of the new liens or replacement liens that will be put on the debtor’s assets will be outlined in the motion and the orders that follow. This is significant because those fresh lien petitions can ask for priority over the products and assets that the debtor’s suppliers delivered or might provide.

Sellers of goods should carefully analyze these new security grants to make sure that no existing liens are accidentally given priority over them and that any appropriate carve-outs to the lien package are taken care of. Additionally, the motion will specify how much money has just been available to the debtor (as opposed to that portion that is rolled up from a pre-bankruptcy loan and therefore not an enhancement to liquidity). The lending facility’s face amount could give a false impression of the debtor’s financial situation. With new covenants and milestones that may relate to the timing of draws, termination dates, and events of default based on sales revenue and other deadlines, lenders may frequently also try to control or restrict the debtor’s operations.

A budget, often in the form of a 13-week cash flow forecast, is another important piece of information that can be included in the majority of DIP financing moves. DIP finance orders frequently stipulate that the debtor must adhere to the budget’s spending and revenue targets, with some agreed-upon weekly variances for specific line items. The budget will be updated weekly or monthly and will contain useful details about the anticipated cash condition of your customer. The budget may also shed light on the proceeds that are available to the debtor, which may occasionally differ from the loan’s face value, which may have been exaggerated for show.

When deciding whether or how much business to conduct with a debtor, suppliers should carefully assess all of these factors, including the amount of fresh financing, the consequences of covenants and other loan requirements, and the budget constraints.

7. Examine the operating reports every month

Debtors must publish monthly operations reports that detail their expenses as well as a balance sheet of their current cash. These reports give information about the debtor’s acquisition, management, and transfers of its assets throughout the case, and they give interested parties the chance to gauge the chances of a successful reorganization as the case develops. The reports will describe, among other things, the sum of professional fees paid, the degree of distributions made, and the sales of any assets. Monthly operating reports may draw attention to an alteration in conditions that might lead suppliers who have decided to keep doing business with a debtor to reconsider or adjust the terms of their contracts.

8. Investigate the aftermarket

While some bankruptcy cases can be resolved quickly (some in as little as 24 hours), others may require years of wrangling and court proceedings before a plan of reorganization is approved, and even longer before disbursements to creditors can start.

Therefore, it might be in your company’s best advantage to look into options for selling its claim to a third party buyer in exchange for quick cash payments. And if you discover your name on a public creditor list, many distressed investors might contact you with uninvited offers. With the help of counsel or advisors who are aware of other funds or investors who might be interested in beginning or expanding a position in the in question claims, it’s likely that you can do better than what they will give. Even while a creditor might not be eager to sell at market value, the secondary market might nonetheless offer a rough estimate of the claim’s value for internal bookkeeping needs.

Lawyers with experience in the secondary market will be able to help creditors navigate the process quickly and offer advice on alternatives.

9. Examine your payment record

When a counterparty files for bankruptcy, one of the biggest worries for creditors is frequently the possibility of having payments received before bankruptcy clawed back. Even while it hurts to have your company’s claims not fully honored, it might be worse to give the debtor money that you think they should have received before the lawsuit even started.

The debtor (or a trustee designated by the court) will frequently demand that the creditor repay all payments received within the 90 days prior to the bankruptcy filing if the creditor delivered goods or services to the debtor during that time. Any payments made for or on account of an antecedent debt (payments made after goods or services are supplied) during the 90 days prior to the filing, when the debtor was insolvent (which is assumed during the 90-day period), may generally be susceptible to avoidance as a preferential transfer.

Although plaintiffs must consider a receiver’s potential defenses when determining whether to pursue claims, this obligation is vague, so demands (and later expensive adversarial actions) may be pursued without regard for the recipient.

The most common justification used by creditors is that the actions were conducted in the normal course of business. The fact that the payments in question were provided consistently as part of the customary payment arrangement between the parties is, in general, a defense to a preference demand. Suppliers paid throughout the 90-day window should review their payment history with the debtor, both recently and historically, to see if they could be seen to be conducting a preference relationship. If so, they should prepare any necessary defenses.

This necessitates that the creditor provide specific information regarding the dates of the invoice, payment, and check clearing. Analysis of the usual course can be done in a number of ways, such as determining if the subject payments were made within the historical average, median, or range of days between invoice and payment (or some combination thereof). A creditor will be best equipped to proactively handle it and avoid unpleasant surprises if it is aware of its exposure early on and is able to model viable defenses.

Importantly, the debtor will include a timeline of payments made over the 90-day period in its early-filed Statement of Financial Affairs, giving creditors a starting point for any conversations with the debtor. A proactive approach may lessen (or eliminate) any risk because many preference actions are settled out of court due to the subjective nature of usual course.

10. When speaking with the debtor, use caution

The automatic stay takes effect right away once the case is filed, barring any negative actions against the debtor or its assets if a contract was illegally terminated prior to the filing of a petition (importantly, including the passing of any cure- or payment-periods). This statutory stay prohibits, among other things, the delivery of demand notices, the exercise of otherwise lawful termination rights, and the institution of a bank setoff (the taking of money from the account of the debtor to pay your company) against prepetition accounts receivable. Counsel should first request release from the stay (by submitting a motion to the court) or a declaration that the stay does not apply to the intended actions before conducting any such action.

It is legal to enforce termination rights that are brought about by the debtor’s financial situation, most frequently by the filing of a bankruptcy petition, though the idea is broad. When deciding whether to conduct any post-petition steps against the debtor, creditors must be extremely cautious because a knowing violation of the stay could result in penalties. Additionally, it is wise to proceed cautiously when a counterparty’s parent has filed for bankruptcy because, in very unusual circumstances, the automatic stay may be thought to apply to a debtor’s non-debtor subsidiaries.

You are nearly there

Every general counsel should have access to all of these tactics in the event that a counterparty files for Chapter 11 bankruptcy. But in addition to your various job-specific specialties, handling a bankruptcy requires a degree of competence you might not have. Therefore, dealing with bankruptcy is one area in which you might suggest using an outside law firm.

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