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Doing business in troubled times

Kaaran Thomas

Everyone knows the economy is in trouble. What most people don’t know is how to avoid the pitfalls involved with doing business with troubled companies and individuals. Whether it’s a new deal like a purchase, sale or loan, the settlement of a lawsuit or the negotiation of a long-term lease or business relationship, the business issues should be tailored with a view towards a future bankruptcy filing. Although most of the tailoring should be done by attorneys who are experienced in bankruptcy and workouts there are some problems any business man can identify. Knowing that there is a potential problem will help to get a lawyer involved early enough in the deal to avoid bankruptcy pitfalls.

It’s not always easy to tell when a company or individual is a candidate for bankruptcy. Most types of individuals and companies except for banks, savings and loan companies and insurance companies can file bankruptcy even if they are not “bankrupt.” Even cities and counties can file a special type of bankruptcy.

Individuals and companies can file a Chapter 11 bankruptcy and remain in possession and control of their assets. Troubled businesses often try to settle disputes and work out problems with an eye towards unwinding the settlement or workout if and when they must file for bankruptcy.

Once in a Chapter 11 bankruptcy the “debtor in possession” or estate representative has remarkable powers that are not available outside of bankruptcy. These powers include selling property free and clear of liens; obtaining a “priming lien” to finance the operations of the bankruptcy estate; rejecting leases and other types of long-term agreements; restructuring debts; “avoiding” security interests and mortgages and other transfers of money and property that occurred up to two years before the bankruptcy case is filed; recovering gifts and other transfers of property made with intent to defraud creditors or made for less than reasonably equivalent value; forcing creditors to take little or no money on their claims and getting a discharge or release of debts.

The bankrupt is protected by an automatic stay that prevents creditors from taking any action to collect or pursue their claims. In a Chapter 11 the bankrupt can continue to conduct business, protected by the stay, without a court order. Thus it is too late for creditors to fix or address problems in their dealings with the bankrupt.

Although it is always wise to hire a good bankruptcy attorney, there are things a smart business person can (and should) do to protect your interests before and after a bankruptcy is filed:

Before bankruptcy

Be diligent: Bankruptcy penalizes the careless and rewards the careful. If you are claiming a security interest or mortgage you must be certain that all of the documents describing your security and “perfecting” the security (such as UCC-1 financing statements) must be exactly correct and must be filed on time. Check your debt and security instruments before you take action that could push someone into bankruptcy (like threatening to foreclose or sue). If you delay or fail to file a proper UCC-1 or mortgage, or if you fail to file the documents in the proper place, you may lose your security.

Be informed: Certain rights are triggered or limited by a bankruptcy filing and certain actions are stayed by the filing. So it is important to know if a person has filed. The bankrupt may not have filed in the place where they are doing business with you. A bankruptcy case can be filed in the state where the bankrupt is incorporated, where it has its principal place of business or where it has its principal assets. If the bankrupt is part of an affiliated group of companies, the bankrupt can file where any affiliate can file. Thus the Tropicana and the Montbleu casinos both recently filed bankruptcy in Delaware. You can get information about bankruptcy cases on PACER. A PACER account will let you find out who has filed bankruptcy and get copies of information filed in the bankruptcy case. The Pacer system also has a national index for U.S. district, bankruptcy, and appellate courts at https://pacer.login.uscourts.gov.

Be careful: There are many things to be careful of before a bankruptcy case is filed. Here are a few:

* Settling disputes with troubled companies seems like a commendable idea. However, if you give up rights (like the right to record a judgment lien or to be paid in full) as part of a settlement in exchange for a promise of a future payout and the payer files bankruptcy, the bankruptcy estate can recover the payments made to you within the 90 days before bankruptcy. Meanwhile, you do not have the right to revive the claims and/or liens and/or rights that you have given up in the settlement. You are “stayed.” Settlements have to be carefully structured to bankruptcy-proof the benefits you are getting and the things you have given up.

* Troubled companies and individuals are often desperate to raise cash and will sell valuable assets at deep discounts. These “great deals” should raise red flags. If the seller files bankruptcy within two years after you buy the asset you may have to give the asset back. A sale for less than reasonably equivalent value can be set aside as a fraudulent transfer under the Bankruptcy Code even if no fraud was intended. Being a bona fide purchaser is no defense.

They filed. Now what?

Your borrower, developer, lessee, supplier or buyer just filed bankruptcy. You might be tempted to sit and wait for the notice from the bankruptcy court telling you to file a proof of claim, or the notice that says when the meeting of creditors is to be held, or the notice that tells you the bankrupt has no assets. However, there are things that can, and some that must, be done in the first days after the bankruptcy filing to protect and preserve your position. Here are a few things that can and should be done, depending on your relationship to the Bankrupt.

* Continue to “perfect” your lien with a “notice of perfection. ” A bankruptcy filing creates an automatic stay that acts like an injunction. The term “automatic” means that the stay goes into effect without a court order and without the need to notice adverse parties. In most parts of the United States actions taken after the bankruptcy that violate the stay are void. For example, you are a mechanic lien claimant and the time to file your lien notice is about to expire when you learn that the property owner has filed bankruptcy. If you file your lien notice without getting relief from the stay, the lien notice is void and so is your lien. What to do? Fortunately the bankruptcy code provides a simple alternative – a Notice of Perfection – but you should immediately hire a lawyer to prepare and timely file one.

The Notice of Perfection is available for any creditor who must take steps under state law to “perfect” their lien (like filing a Lien Notice or a UCC-1 or mortgage). A creditor cannot wait or argue that they didn’t find out about the bankruptcy. Failure to file the notice within the time provided by state law will result in losing your lien.

* File a notice to reclaim “identifiable goods” sold on credit. If you have sold goods on credit to the bankrupt in the ordinary course of your business; the bankrupt was insolvent when the goods were received and the goods were received within 45 days before the bankruptcy was filed you have the right to reclaim (get back) the goods that you can identify. However, the “Notice of Reclamation Rights” must be filed on the later of 45 days after the bankrupt received the goods or 20 days after the date the bankruptcy was filed if the 45-day period expired after the bankruptcy was commenced.

* Stop collection efforts. The automatic stay also stops collection efforts, even if you don’t know of the bankruptcy filing. When the bankrupt is an individual, the continuation of collection efforts can result in a judgment of damages against you even if your actions were unintentional and even if you stopped or reversed your efforts as soon as you found out about the bankruptcy.

* Locate your collateral. Once a bankruptcy is filed you should be able to speak with a representative of the bankruptcy estate a Chapter 7 trustee or his counsel; bankrupt’s counsel or Chapter 13 trustee in a Chapter 13 and the lawyer for the Chapter 11 estate. You can also call the local office of the United States Trustee, who acts as the ultimate overseer of all cases.

Bankruptcy creates chaos for the bankrupt’s affairs and business. Property can be left unguarded and in some cases can be removed by employees, creditors and sometimes even by the bankrupt. You are stayed from taking possession of your collateral but you can still locate and inspect the property and take pictures if possible. Tampering with the property of a bankruptcy estate is a federal crime, but it often goes unpunished because there is no one who knows about it. If your property or collateral is valuable it is worth protecting. If you find a problem or cannot locate the property, contact the estate representative and copy the local office of the United States Trustee.

You can also attend the “meeting of creditors” also known as the 341 meeting and ask the bankrupt under oath. The meeting is generally held within two months after the bankruptcy is filed. You don’t need an attorney to represent you at the meeting.

* Be wary about filing a claim. Filing a claim seems like a simple process. Informa-tion on claim filing is available by calling the bankruptcy court clerk.

However, filing a claim is not always a good idea. In a Chapter 11 case you may not have to file a claim if your claim is listed on the bankrupt’s schedules as undisputed. If you are involved in a dispute or lawsuit with the bankrupt, filing a claim will subject you to the bankruptcy court jurisdiction for all counterclaims the bankrupt might decide to bring against you. This means that you have just lost your right to have a trial on the bankrupt’s case in your home court. You may find yourself defending a lawsuit filed by the bankrupt in bankruptcy court in New York or Delaware. You have also waived your right to a jury trial, even if there is litigation with the bankrupt already started somewhere else. If you know the bankruptcy estate has lots of money to pay your claim, you don’t mind appearing in the bankruptcy court wherever it is and you think you have a great defense against the bankrupt’s claims, consider filing your claim. If you are not sure, discuss the issues with a lawyer and do some investigation about the bankrupt’s case.

* Get a good lawyer. Bankruptcy is a trap for the unwary. You must know your rights and promptly protect them. The list above is not exhaustive there are many things to watch for and protect, depending on your situation. It is always best to hire an attorney who is knowledgeable about bankruptcy matters and your particular issues.

Kaaran Thomas, an attorney with McDonald Carano Wilson in Reno LLP, is one of two practicing attorneys in Nevada who are fellows of the American College of Bankruptcy, the national honorary society for specialists in bankruptcy and business reorganizations.