Tag: bankruptcy code

A Primer for Creditors Navigating the Bankruptcy System

Bankruptcy filings affect businesses across America.

The Bankruptcy Code is complex and difficult to navigate. But used properly, it can help creditors to minimize losses when a customer files bankruptcy. This article will guide you on how to stay out of trouble and improve your chances of getting paid by a bankrupt customer.

What Does the Bankruptcy Filing Mean?

The Bankruptcy system serves three basic purposes: It (i) provides a single forum to deal with the assets and liabilities of an insolvent debtor, (ii) provides the honest, but unfortunate, debtor with a “fresh start,” and (iii) if a debtor chooses to reorganize its debts, it provides a process for saving and preserving the going-concern value of a business.

Bankruptcy has different chapters depending on the debtor’s objectives. Chapter 7 is liquidation. A trustee is appointed to take control of and sell the debtor’s property. Typically, the Customer’s assets will be surrendered to those creditors holding security interests sold by the trustee to generate proceeds for distribution to creditors. Individuals or businesses may file Chapter 7, but only individuals can obtain a discharge of their debts.

Chapter 13 is called the “wage-earner” filing, and it’s available to individuals only. In a Chapter 13, the debtor keeps his or her assets and proposes a three to five-year payment plan. Depending on several factors, including the debtor’s income and available assets and whether you are a secured or unsecured creditor, recovery can vary. Similar to Chapter 7, Chapter 13 has a trustee. But his or her role is to be a monitor and conduit for distributing plan payments to creditors.

Chapter 11 bankruptcy is a reorganization proceeding available to businesses and wealthier individuals whose debt levels exceed the less burdensome Chapter 13 requirements. Similar to Chapter 13 cases, the Customer will file a plan of reorganization outlining the Customer’s proposal to modify and repay debts. However, in Chapter 11 cases, creditors generally take a more active role in the proceeding and plan approval process to ensure that their rights are preserved and not adversely affected by the Customer’s proposed plan. Once a plan has been approved by the Bankruptcy Court, payments are made pursuant to its terms.

The Automatic Stay

Immediately upon the Customer’s bankruptcy filing, a substantial impact on a creditor’s ability to exercise its rights is imposed. The “automatic stay” provision of the Bankruptcy Code stops creditors in their tracks from virtually any collection activity against Customer, providing Customer with room to reorganize its debts without the threat of collection actions from their creditors.

Any action to collect the balance of the money the Customer owes or to recover the property now under the protection of the Bankruptcy Court is considered a violation of the stay. Similarly, actions to obtain, perfect, or enforce a lien on property of the bankruptcy estate are prohibited. Further, if the Customer files under Chapter 13 and the debt owed is a “consumer debt” (i.e., a debt incurred for personal, as opposed to business, needs), the “co-debtor stay” prevents actions to collect from individuals jointly liable with Customer on that debt, even if they have not filed their own bankruptcy case.

In light of the automatic stay, proceeding with great caution is of the utmost importance. In the event of willful violations of the automatic stay, the Customer may be awarded sanctions against the creditor, including payment of fines, the Customer’s attorneys’ fees, and/or the creditor losing rights in the bankruptcy case itself. If you receive notice that the Customer is seeking sanctions for your violation of the automatic stay, quickly seek the assistance of knowledgeable legal counsel to minimize your exposure.

Payment Rights and Other Remedies

In certain instances, you may be entitled to “relief” from the automatic stay. If relief is granted by the Bankruptcy Court, creditors may proceed with taking those actions initially prohibited at the outset of the bankruptcy case. For example, a creditor may be able to obtain relief and file suit against a non-filing individual that was once protected by the co-debtor stay, in order to preserve its rights and increase the likelihood of payment on the delinquent account.

If it is customary for you to sell goods on credit, and if goods were sold to Customer within 45 days immediately preceding the bankruptcy filing, you may be able to reclaim the goods from the Customer. You may also be entitled to assert an administrative priority claim for the value of any goods sold to Customer in the ordinary course of business during the 20 days immediately preceding the bankruptcy filing. To avail yourself of these options, formalities and procedures must be strictly followed, and quickly, to avoid expiration of your rights.

Some debts may be “non-dischargeable.” In other words, if the creditor can show some exception to the general rule (e.g., debts incurred through fraud, larceny, or embezzlement), the debt will not be discharged, and the Customer will remain responsible to you for repayment at the conclusion of the proceeding. Again, there are strict burdens and time requirements for creditors seeking to have their claims declared non-dischargeable, so creditors should closely monitor those deadlines and discuss with their legal counsel to preserve their rights.

Finally, you can also file a Proof of Claim with the Bankruptcy Court evidencing the debt owed to you by the Customer. Coming as no surprise, this option similarly imposes strict burdens and deadlines on filing requirements. Acting early is advisable, ensuring your claim is recognized, and you are kept abreast of the status of the bankruptcy proceeding. Filing a Proof of Claim does not guaranty repayment but does preserve your right to payment in the case.

Every bankruptcy filing is different, and the underlying facts will impact your rights and influence your overall collection strategy. Proactively seek guidance on proper pre-bankruptcy loss mitigation efforts and understand that all risks of loss cannot be avoided. If a customer does file bankruptcy, act carefully, but quickly to meet deadlines, preserve rights, mitigate losses, and receive payment during the life of the case. The most effective way to do so is by seeking competent legal counsel experienced in navigating the complex and intricate bankruptcy system.

© 2024 Ward and Smith, P.A.. All Rights Reserved.
For more news on Navigating the Bankruptcy Code, visit the NLR Bankruptcy & Restructuring section.

The Unredeemable Debtor

The law is the witness and external deposit of our moral life. Its history is the history of the moral development of the race.

– Oliver Wendell Holmes

Bankruptcy law decisions are replete with references to the “worthy debtor.”  In re Carp, 340 F.3d 15, 25 (1st Cir. 2003); In re BankVest Capital Corp., 360 F.3d 291 (1st Cir.2004); In re Institute of Business and Professional Educ., Inc., 79 B.R. 948 (Bankr. S.D. Fla. 1987); In re Nickerson, 40 B.R. 693 (Bankr. N.D. Tex. 1984); In re Marble, (Bankr. W.D. Tex. 1984); In re Doherty, 219 B.R. 665 (Bankr. W.D. N.Y. 1998).

These decisions typically employ the “worthy debtor” nomenclature in the context of the entitlements that are afforded by the provisions of the Bankruptcy Code.  It is always the “worthy debtor” that is entitled to a discharge of debts, a “fresh start”,  or to reject cumbersome contracts. This usage bespeaks a universe that also contains the “unworthy debtor,” a party whose behavior does not merit the statutory benedictions of the Bankruptcy Code. The identity of these parties is most often examined in the context of the discharge of debts and the behavior or actions that merit a denial of discharge or the finding that a particular debt is non-dischargeable.

There is a larger and more amorphous question though that also merits consideration, namely are their industries, companies, enterprises whose function and purpose is so odious and inconsistent with the precepts of good citizenship and the “moral development of the race”, to quote Justice Holmes, that they should be denied the benefits of reorganization afforded by the Bankruptcy Code.

If there is an argument to be made to prevent such enterprises from receiving the benefits of the Bankruptcy Code, to deny them the colloquial label of “worthy debtor”, that recourse likely lies within the provisions of the Bankruptcy Code that require that a plan of reorganization be “proposed in good faith and not by any means forbidden by law.”  11 U.S.C. § 1129(a)(3).  The “not forbidden by law” requirement is of limited utility in situations where the behavior is recognizable as immoral or intrinsically evil to most but has not yet been sanctioned by any legislative authority. Notably, and perhaps inversely, enterprises engaged in the sale and growing of cannabis are without access to the Bankruptcy Code because they act in contravention of the federal Controlled Substances Act, 21 U.S.C. §§ 801 et seq., which has been found to take precedence over state laws allowing the sale of cannabis. See, Gonzales v. Raich, 545 U.S. 1, 12 (2005).  As a result, bankruptcy being a creature of federal law, cannabis cases are generally being dismissed at the outset for cause in accordance with 11 U.S.C. § 1112(b) and not making it as far as the confirmation standard. See, In re Way To Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018).

If “forbidden by law” is unavailable as a source of relief, the last best hope to prevent the sanctioned reorganization of the unworthy debtor lies within the requirement that a plan be proposed in “good faith.”

“Good faith” is not defined by the Bankruptcy Code, a fact that makes it more likely that our  understanding of good faith may be transitory and that as the ‘moral development of the race’ proceeds, so might our understanding of ‘good faith.’  In other words, what was good faith yesterday might not, in light of our communal experience and growth as citizens, be good faith today.

In the first instance, we can understand from the ordering of the words within section 1129(a)(3) that the good faith standard exists independently of the ‘forbidden by law’ standard.  A plan of reorganization may describe a course of action not forbidden by law, but may still not meet the ‘good faith’ standard.

The good faith standard as used within section 1129(a)(3) is most commonly described as proposing a plan that fulfills the purposes and objectives of the Bankruptcy Code.  Those purposes and objectives within the context of Chapter 11 are most commonly understood as being “to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.”  NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1983);  see also, Bank of Am. Nat. Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 452 (1999) (“[T]he two recognized policies underlying Chapter 11 [are] preserving going concerns and maximizing property available to satisfy creditors”)

This case law, which is by far the most consistent usage of the term, emphasizes paying back creditors and preserving an ongoing enterprise. It does not suggest the existence of anything more amorphous beyond those standards and it supports the idea that the ‘good faith’ standard is not meant to be an existential inquiry into the moral worth of a particular industry.

Bankruptcy courts have, however, recognized that the absence of a definition of good faith leaves courts without “any precise formulae or measurements to be deployed in a mechanical good faith equation.”  Metro Emps. Credit Union v. Okoreeh–Baah (In re Okoreeh–Baah), 836 F.2d 1030, 1033–34 (6th Cir.1988) (interpreting good faith in context of Chapter 13).

Any successful collateral attack under section 1129(a)(3) on the ‘good faith’ of the immoral enterprise must likely follow the path of connecting the good faith standard to the “public good.”  Bankruptcy Courts have invoked the ‘public good’ in refusing to enforce certain contracts and have followed the dictates of some courts that “while violations of public policy must be determined through “definite indications in the law of the sovereignty,” courts must not be timid in voiding agreements which tend to injure the public good or contravene some established interest of society. Stamford Bd. of Educ. v. Stamford Educ. Ass’n., 697 F.2d 70, 73 (2d Cir.1982).

The concept of the ‘public good’ is not a foreign one in bankruptcy courts.  Seeking relief for debtors that are the only providers of a service within their geographic area is an immensely easier task, no court, and no bankruptcy judge, likes to see a business fail and when the business is important to the community, support for reorganization from the bench often works to make reorganization easier.  Bankruptcy courts, although restrained by a statutory scheme, are as a matter of practice courts of equity.  Employing those equitable arguments to support a reorganization is both achievable and a reality of present practice.

Whether equitable arguments can be inversely employed to graft a sense of the ‘public good’ onto the good faith requirement within section 1129(a)(3) is decidedly uncertain and is not directly supported by the case law as it exists.

Somewhere out there though in one of those small border towns between the places of unelected legislators and the judicious and novel application of historical precedent lies the “moral development of the race” and the bankruptcy court that finds that incumbent within the concept of good faith is fair consideration of the public good.

Article By Peter J. Haley of Nelson Mullins

For more bankruptcy and restructuring news, click here to visit the National Law Review.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLP

Debt Ceiling Shrinks for Small Business Bankruptcies

Subchapter V of Chapter 11 of the Bankruptcy Code, which took effect in February 2020, creates a more streamlined and less expensive Chapter 11 reorganization path for small business debtors.  Under the law as originally passed, to be eligible for Subchapter V, a debtor (whether an entity or an individual) had to be engaged in commercial activity and its total debts — secured and unsecured – had to be less than $2,725,625.  At least half of those debts must have come from business activity.

In March 2020, in response to the COVID-19 pandemic, Congress passed the CARES Act, which raised the Subchapter V debt ceiling to $7.5 million for one year.  Congress extended it to March 27, 2022.  A bipartisan Senate bill would make the Subchapter V debt limit permanent at $7.5 million and index it to inflation.  But Congress has not yet passed the legislation or sent it to President Biden for signature.  So, for now, the debt ceiling has shrunk to the original $2,725,625.

Subchapter V has proven popular, with over 3,100 cases filed in the last two years (78 in North Carolina).  Many of those cases could not have proceeded under Subchapter V but for the higher debt limits.  The American Bankruptcy Institute has reported that Subchapter V cases are experiencing higher plan-confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed as a traditional Chapter 11.  Anecdotally, most debtors in North Carolina are filing under Subchapter V if they are eligible.

We will continue to monitor legislative activity and report if Congress passes a law to reinstate the $7.5 million debt ceiling.

Article By Lance P. Martin of Ward and Smith, P.A.

For more financial and business legal news, click here to visit the National Law Review.

© 2022 Ward and Smith, P.A.. All Rights Reserved.