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My customer filed for bankruptcy! What do I do now?

Brian Irvine

Despite recent signs that the national and Nevada economies are improving, and despite the 26 percent drop in bankruptcy filings in northern Nevada from 2011 to 2012, it is likely that a full economic recovery in northern Nevada may still be far away. Nevada remains one of the four states with the highest per capita rate of bankruptcy filings. This means that if you are in business in northern Nevada, it is likely that one of your customers will file for bankruptcy protection. Perhaps that customer owes you a significant amount of money, or you have just sent them a large shipment. In those types of situations, what can you do to protect your business?

The answer is: You can do a lot. But exactly what you should do depends on your business, your relationship with the debtor, the type of bankruptcy filed, and other factors. This article is designed to provide some basic information about bankruptcy, and identify some of the simple steps a business owner can take to protect its interests as a bankruptcy creditor. However, bankruptcy can be a complicated process, and you may be best served by consulting with an experienced creditors’ rights attorney.

Stop collection efforts

The first thing you need to do is stop all efforts to collect money from the debtor. Under the Bankruptcy Code, the filing of a bankruptcy case imposes an automatic stay of all pending or potential actions to collect on pre-bankruptcy debts. This means that you cannot make any collection efforts against the debtor for money you were owed before the bankruptcy. If you continue collection efforts after the filing of a bankruptcy, the bankruptcy court may impose sanctions against you. If the court decides that you “willfully” violated the automatic stay, you may have to pay damages, attorney’s fees and punitive damages.

Understand what the debtor is attempting to accomplish

Bankruptcy is a process in which individuals and businesses can eliminate or repay some or all of their debts under the protection of the federal bankruptcy court. For the most part, bankruptcies can be divided into two types liquidation and reorganization.

Chapter 7 bankruptcy comes under the liquidation category and is available to both individuals and businesses. It is called liquidation because a bankruptcy trustee is appointed to take and sell (“liquidate”) some of the debtor’s property to pay back debt.

There are several types of reorganization bankruptcies, but Chapter 13 is the most common type for individuals. In Chapter 13 bankruptcy, the debtors get to keep all of their property, but must make monthly payments over three to five years to repay all or some of their debt. Chapter 11 is typically used by financially struggling businesses to reorganize their affairs. In a Chapter 11, debtors generally work toward creating a court-approved plan of reorganization. The plan of reorganization must include a classification of claims and must specify how each class of claims will be treated under the plan (essentially, how the debtor plans on treating each creditor to which it owes money). Creditors typically vote on the plan by ballot, and then the court will conduct a hearing to determine whether to confirm the plan.

In all types of bankruptcies, debtors have the common goal of attempting to “discharge” their debts. A bankruptcy discharge releases debtors from liability for certain types of debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. Therefore, once the debtor has completed the bankruptcy process, you are no longer entitled to receive the full amount you were owed prior to the bankruptcy, so it is very important to put your business in the best possible position within the bankruptcy process in order to maximize the amount of money you are able to recover.

Get involved and file a proof of claim

One of the first steps that you can take as a creditor is to consider filing a notice of appearance with the bankruptcy court to receive copies of all of the filed pleadings. This will ensure that you always know what is being filed during the pendency of the case, including motions, notices of hearings and proposed plans of reorganization. However, there is some downside to this approach. Bankruptcy cases involve a lot of paper. If you file a notice of appearance, you will receive, typically via email, a copy of every pleading filed in the debtor’s case. The average bankruptcy case will have dozens, if not hundreds, of pleadings filed. The amount of information you receive can become overwhelming, and most people that are unfamiliar with the bankruptcy process struggle to understand what all of the pleadings mean.

Another important step is to file a “proof of claim.” Generally, any creditor whose claim is not scheduled (i.e., listed by the debtor on the debtor’s schedules) or whose claim is disputed by the debtor, must file a proof of claim (and attach evidence documenting the claim) in order to be treated as a creditor for purposes of voting on the plan and distribution under the plan. Filing your claim promptly after the case begins will ensure that you do not inadvertently miss a deadline for filing a proof of claim. In many Chapter 7 and Chapter 13 cases, filing a proof of claim may be all you need to protect your business interests.

Shortly after a bankruptcy case is filed, the United States Trustee’s Office will schedule an initial creditors meeting. During the meeting, the debtor’s representative will have to answer some fundamental questions about the debtor’s plans for operations during the pendency of the bankruptcy, and how it plans to reorganize and repay creditors. Creditors meetings can be an excellent source of early information about your chances of recovering funds in the bankruptcy.

If you are one of the largest creditors for a particular creditor, you may also be asked to serve on a creditors’ committee. The committee is appointed by the U.S. Trustee and ordinarily consists of unsecured creditors who hold the seven largest unsecured claims against the debtor. The committee typically consults with the debtor on administration of the case, investigates the debtor’s conduct and operation of the business, and participates in formulating a plan. A creditors’ committee may, with the court’s approval, hire an attorney to assist in the performance of the committee’s duties. Serving on the creditors’ committee will keep you involved and give you a voice in the bankruptcy process. However, it is not without some downside; members of the creditors committee take on a fiduciary duty to other creditors and can no longer act simply in their own best interests.

Additional steps if you supply goods to the debtor

Under Nevada’s version of the Uniform Commercial Code (UCC), a supplier has the right to stop the shipment of goods if, before the goods are delivered, it discovers that its customer is insolvent. Accordingly, if you are a supplier, you should determine the status of any shipments of goods to the debtor and, if possible, stop delivery of such shipments.

Even if the debtor has already received your goods, you may also have the ability to recover those goods. Nevada law and the Bankruptcy Code also give a supplier the right to reclaim goods where the buyer has received those goods shortly before filing bankruptcy. To do so, the seller must assert a written reclamation demand as soon as learning of the bankruptcy, as delay can limit your ability to recover goods. It is important that this written demand specifically state that it is asserting the “right of reclamation” under bankruptcy and applicable state law and be sufficiently detailed to permit the debtor to identify the goods being reclaimed.

Finally, even if you fail to make a reclamation demand, the Bankruptcy Code gives you administrative expense priority for the value of any goods the debtor receives within 20 days before the debtor’s bankruptcy case begins, assuming you sold the goods to the debtor in the ordinary course of business.

Consult with experienced creditors’ rights counsel

Get experienced counsel to assist you. Your customer’s bankruptcy raises many complex legal issues with respect to matters of commercial law, the impact of the automatic stay, and the assertion of state law rights in the bankruptcy arena. Many of these issues are unique to bankruptcy and unfamiliar to most attorneys. Creditors’ rights counsel with experience in such matters can most effectively help you in protecting your interests. If you do not properly exercise your rights, you can recover far less money to which you are entitled, or worse.

Brian Irvine is a shareholder at the law firm of Gordon Silver in Reno. He works in the firm’s litigation department.