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Vendor’s Checklist When a Customer Files for Bankruptcy
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Vendor’s Checklist When a Customer Files for Bankruptcy

June 1, 2016 Banking & Financial Services Industry Legal Blog

Reading Time: 12 minutes

Many vendors have had the unfortunate experience of a customer filing for bankruptcy.  If it hasn’t happened to you yet, it probably will at some point in the future.  There are certain steps a vendor should (or must) take to protect itself and maximize its opportunity to collect any debts owed by the customer.  Vendors that take advantage of these protections can maximize recoveries, better preserve their positions in their dealings with the debtor, and avoid pitfalls inherent in the bankruptcy process.  Vendors, and their attorneys, should use this checklist and take immediate action when a customer files for bankruptcy.

Gather Information and Review the Business Relationship

  1. Gather and review the contract documents including any credit application, personal guarantees, and invoices.
  2. Determine whether all the entities liable for the debt actually filed for bankruptcy.
  3. If there is no ongoing business with the debtor, consider whether to continue doing business and, if so:
    1. determine ways to ensure payment for postpetition deliveries (for example, requiring a cash deposit, letter of credit, or payment on a CIA or COD basis); and
    2. if the payments would constitute cash collateral, ensure there is a cash collateral order in place.

Initial Steps in the Bankruptcy Case

  1. File a notice of appearance to receive future pleadings, motions, and other documents filed in the case.
  2. Determine whether the bankruptcy is a Chapter 11 or Chapter 7 case because the debtor’s operations generally continue under Chapter 11, but terminate under Chapter 7.
  3. Obtain copies of all filed documents to understand what happened. Some of these documents are mailed to creditors or can be obtained through the Public Access to Court Electronic Record (PACER) system.
  4. Identify and calendar any upcoming deadlines.
  5. Attend the section 341 meeting for an opportunity to examine the debtor under oath about its assets, liabilities, and intentions regarding reorganization.

Avoid Violating the Automatic Stay

  1. Cease all collection activities and inform all employees handling the debtor’s account of the debtor’s bankruptcy to avoid inadvertent violations of the automatic stay.
  2. Cease litigating all prepetition judicial, administrative, or other proceedings against the debtor. If there is a reason that the action, or some portion of it, must proceed immediately, file a motion seeking relief from the automatic stay.
  3. Separate prepetition and postpetition obligations in correspondence and invoices.
  4. Apply postpetition payments only to postpetition invoices (since the automatic stay bars collection efforts for prepetition debts).

File a Proof of Claim by the Bar Date

  1. File a proof of claim as early as possible.
  2. Identify the bar date and file a proof of claim as far in advance as possible of that date to allow for the most flexibility to correct any errors or make amendments.
  3. Monitor the case docket for any objections to the proof of claim, the deadline for responding to the objection, and the date of the hearing on the objection.

Stop Delivery of Goods

  1. Stop delivery of goods sold on credit:
    1. not yet shipped to the debtor, as permitted under Sections 2-702(1) and 2-703 of the Uniform Commercial Code (UCC), unless the debtor pays cash; or
    2. while in transit, as permitted under Section 2-705 of the UCC, if the debtor has not taken actual or constructive possession or control of the goods.
  2. After delivery is stopped, convert the credit sale into a COD sale or arrange for the return of the goods from the carrier, warehouse, or other third party holding the goods.
  3. Ensure there is a cash collateral order in place before accepting a cash payment (see below Confirm the Debtor’s Authority to Use Case Collateral).

Consider Reclamation Rights

  1. Consider making a timely written reclamation demand to the debtor for goods sold in the ordinary course of the vendor’s business and received by the debtor within 45 days of bankruptcy. The vendor must assert this demand within:
    1. 45 days of the debtor’s receipt of the goods; or
    2. 20 days after the petition date, if the customer filed for bankruptcy within 45 days of receiving the goods.
  2. Determine whether the bankruptcy court has entered an order approving universal procedures for resolving reclamation claims, and assert reclamation claims accordingly.
  3. If the court has not entered universal reclamation procedures and the debtor has not sent a satisfactory response to the reclamation demand, immediately commence an adversary proceeding by filing a reclamation complaint in the bankruptcy court, including a request for a temporary restraining order preventing the debtor from moving, selling, or altering the goods until the hearing on the complaint, or at least permitting the vendor access to the goods and debtor’s records.
  4. If receiving critical vendor treatment, check whether the critical vendor order prohibits the assertion of reclamation claims (see below Consider Seeking Vendor Treatment).

Assert Section 503(b)(9) Claims

  1. Determine whether the bankruptcy court has entered procedural orders in the local rules governing the process for asserting section 503(b)(9) claims and assert these claims accordingly. These orders generally establish procedures streamlining the processing of section 503(b)(9) claims and may require vendors to:
    1. use a particular form to assert their claims that differs from the standard proof of claim form;
    2. provide specific supporting documents;
    3. meet shortened deadlines for filing their claims that are asserting all other claims.
  2. If the court has not entered procedural orders governing the filing of section 503(b)(9) claims, file a motion requesting payment of the section 503(b)(9) claim.

Perfect Mechanics’ Liens

  1. If applicable, perfect any mechanics’ liens within the time period established by applicable nonbankruptcy law.
  2. File a section 546(b)(2) notice of perfection, continuation, or maintenance of lien in the bankruptcy court as soon as possible after perfecting the lien, specifying that:
    1. the vendor is perfecting continuing, and maintaining its lien under section 546(b)(2) of the Bankruptcy Code;
    2. the vendor intends to enforce its interest in the property securing the lien;
    3. the vendor does not consent to any sale of the property free and clear of the lien; and
    4. the proceeds of any sale of the property securing the lien are cash collateral under section 363(a) of the Bankruptcy Code and may not be used without the vendor’s consent.

Consider Serving on the Creditors’ Committee

  1. If solicited by the US Trustee to serve on the creditors’ committee:
    1. Consider the advantages and disadvantages of participation.
    2. Promptly complete and return the questionnaire and attend the organizational meeting the US Trustee interviews and appoints committee members.
    3. If live participation at the organizational meeting is not possible, call the US Trustee’s office to reaffirm interest in serving and, if permitted in that particular jurisdiction, act through a proxy.

Seek Critical Vendor Treatment if Appropriate

  1. If debtor is still doing business, and you provide a unique product or service or have unique knowledge of the debtor’s operations, consider whether the benefit of receiving early payment on some or all prepetition claims as a critical vendor is worth the risk of doing business with the debtor.
  2. Negotiate for the following debtor waivers in the critical vendor order:
    1. a section 547 preference waiver for any payments received by the vendor from the debtor during the 90-day period before bankruptcy;
    2. a section 549 disgorgement waiver providing that critical vendor payments to the vendor may not be clawed back if the critical vendor order is reversed; and
    3. a disgorgement waiver providing that critical vendor payments to the vendor may not be clawed back if the case converts to a Chapter 7 liquidation or becomes a liquidating Chapter 11 case.
  3. If the debtor provides a specific list of vendors in its critical vendor motion, and you are not designated as critical, challenge the critical vendor motion by pointing out any inconsistencies and by questioning whether the critical vendor payments made to similar vendors are essential to the debtor’s successful reorganization.
  4. Review the critical vendor order and the critical vendor agreement, to protect against:
    1. open-ended obligations on the vendor to extend unreasonably favorable credit terms to the debtor;
    2. an inability of the vendor to raise prices during the term of the agreement; and
    3. an inability to suspend the agreement if the debtor defaults on its obligations to the vendor or if there are other indications that the debtor’s financial condition is deteriorating.
  5. Ensure that the critical vendor agreement is clearly a postpetition contract, which is not subject to rejection as a prepetition executory contract.
  6. Note that the critical vendor order may preclude the pursuit of reclamation claims.

If You Owe the Debtor Money, Exercise and Protect Setoff and Recoupment Rights

  1. Seek relief from the automatic stay to:
    1. exercise setoff rights against the debtor; and
    2. retain property subject to setoff as a defense to a turnover action requesting the vendor to return property of the estate in its possession of the debtor.
  2. If the debtor requests use of case collateral:
    1. seek relief from the automatic stay to avoid a ruling that refusing to make a payment to the debtor was an exercise of setoff rights in violation of the automatic stay; or
    2. consent to this request only if the form of that consent preserves setoff rights and the debtor provides satisfactory adequate protection.
  3. If the debtor obtains court approval to sell its assets outside of the ordinary course of business in a section 363 sale, insist on adequate protection for any sale of property against which there are setoff rights.
  4. File a proof of claim asserting setoff rights, both to protect against the possibility that a court finds these rights waived and to reserve the right to assert an unsecured claim if there is a deficiency remaining after effecting a setoff.
  5. Properly document any steps involved before effectuating a recoupment during bankruptcy to help defend against a debtor attacking the action as an improper setoff taken in violation of the automatic stay.

Protect Rights Under Executory Contracts

  1. If you have an executory contract with the debtor, request that the court set a deadline by which the debtor must assume, assign, or reject the contract.
  2. If the court will not compel the debtor to make a decision, then alternatively:
    1. request adequate protection during the interim period, such as payment on a COD basis or other relief;
    2. file an administrative claim for the reasonable value of any benefits received by the debtor during the interim period;
    3. examine the debtor and compel production of relevant documents to determine the debtor’s ability to perform the contract; or
    4. exercise state law remedies under Section 2-609 of the UCC to demand adequate assurance of future performance. This can include a demand for assurance that the debtor has obtained either the secured lender’s consent or court authorization to use cash collateral. However, it may be necessary to seek relief from the automatic stay to exercise these rights.
  3. Request the relief from the automatic stay to modify the terms of the contract or exercise termination rights.
  4. Determine whether the debtor is in default under the contract and whether the vendor has waived these defaults. If the debtor assumes the contract and there are unwaived defaults, it must:
    1. cure these defaults, including all non-monetary defaults, or provide adequate assurance that the default will be cured promptly; and
    2. provide adequate assurance of future performance.

Confirm the Debtor’s Authority to Use Cash Collateral

  1. Any postpetition goods supplied to the debtor are entitled to priority as an administrative claim. However, before providing postpetition goods or services to the debtor, and before accepting payment for these goods or services:
    1. Determine whether the payments would constitute cash collateral by checking if a creditor has a valid lien on the debtor’s cash collateral or a blanket lien on all of the debtor’s assets;
    2. If the payments would constitute cash collateral, demand to see a cash collateral order giving the debtor court approval to use cash collateral or confirm that secured creditors with an interest in the cash collateral have consented.
    3. Consider requesting a specific line item on cash collateral or DIP financing budget that references the vendor and authorizes continued payments to it.
    4. Ensure that the court or secured creditor has not revoked this authorization before making each shipment and before accepting each payment.

Monitor the Docket and Exercise Vigilance

  1. Be alert for actions taken in the case that can impair a creditor’s rights and prospects for recover by monitoring the docket for:
    1. debtor-in-possession (DIP) financing or cash collateral motions contemplating giving a lender a lien on all of the debtor’s assets, including unencumbered assets or a superpriority claim over all administrative claims, which include section 503(b)(9) claims and claims for postpetition goods supplied to the debtor; and
    2. sale motions contemplating a sale of the debtor’s assets free and clear of all liens and interests, including mechanics’ liens and setoff rights.
  2. File appropriate and timely objections to preserve the vendor’s rights.
  3. For a sale of a property against which there are setoff rights, request adequate protection.

Proactively Deal With Possible Preference Actions

  1. Identify any possible preferences—typically goods sold to the debtor within 90 days prior to the petition date.
  2. Gather necessary facts to show that:
    1. there was no technical preference (for example, that a non-debtor paid the alleged preference);
    2. all of the elements of a preference are not satisfied; or
    3. a defense applies (for example, the payment was made in the ordinary course of business).
  3. If all of the elements of a preference are satisfied and no defenses apply, negotiate a settlement with the debtor.

Review the Proposed Plan and Disclosure Statement

  1. Review the proposed plan of reorganization and disclosure statement to determine:
    1. whether the claim is classified appropriately under the plan; and
    2. the proposed treatment for that class of claims.
  2. File appropriate and timely objections and vote to reject the plan if dissatisfied with how the plan treats and classifies the claim.
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