1 BANKRUPTCY BASICS FOR VENDORS AND SUPPLIERS Presented to The Virginia Bar Association 11th Annual Corporate Counsel Fall Forum By David K. Spiro, Esquire Robert S. Westermann, Esquire Sheila dela Cruz, Esquire
2 BANKRUPTCY BASICS FOR VENDORS AND SUPPLIERS 1 TABLE OF CONTENTS I. COMMUNICATIONS WITH THE DEBTOR A. Permissible Communications. B. Impermissible Communications. II. PROOFS OF CLAIMS A. Proof of Claim, Generally. B. Requirements for Filing Proof of Claim. C. Common Mistakes. D. Objections to Claims. E. Effect of Filing a Proof of Claim. III. SPECIAL VENDOR CLAIMS, INCLUDING RECLAMATION A. Purpose. B. Expansion of Reclamation Claims. C. Issues Relating to 503(b)(9) Claims. IV. POTENTIAL VENDOR LIABILITY A. Avoidable or Voidable Transfers. B. Preferential Transfers. C. Other Types of Avoidance or Voidance Actions. V. PERSONAL GUARANTIES VI. GLOSSARY OF TERMS 1 For more information regarding the bankruptcy terminology used in this handout, please refer to the Glossary of Terms, Section VI.
3 I. Communications with the Debtor. A. Permissible communications. General communication between you and the debtor (as your customer) is permitted. B. Impermissible communications. Any communications between you and the debtor, which communications are attempts by you to collect on pre-bankruptcy debt(s) and which violate the automatic stay of the Bankruptcy Code and are therefore prohibited. C. Ramifications of engaging in impermissible communications. The Bankruptcy Code provides that any individual (not just the debtor) injured by a creditor s willful violation of the automatic stay is entitled to recover actual damages, including costs and attorney s fees. In certain circumstances, the Bankruptcy Court may award punitive damages against the violator. 2 Take-away Once a debtor files for bankruptcy, a creditor (including all employees of the creditor) should be very careful and not contact the debtor for debt collection purposes. II. Proofs of Claim. A. Proof of Claim, generally. 1. Definition of a claim : a. A right to payment, whether or not reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured; or b. a right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured or unsecured Who must file a proof of claim? A creditor or equity security holder whose claim or interest is not scheduled, or is scheduled as disputed, contingent or liquidated. Any such creditor who fails to file a proof of claim shall not receive a distribution from the debtor s estate Evidentiary impact of a proof of claim. A proof of claim is prima facie evidence of the validity and amount of the claim. 5 Thus, if the debtor does not object to 2 See 11 U.S.C. 362(k)(1). 3 See 11 U.S.C. 101(5). 4 See Fed. R. Bankr. P. 3003(c)(2). 5 See Fed. R. Bankr. P. 3001(f).
4 the proof of claim, then the filing alone of the proof of claim is sufficient to allow the creditor to a distribution from the estate. 4. Secured claims. A creditor whose claim against the debtor is secured by a lien on property in which the debtor s estate has an interest, or that is subject to setoff, is a secured claim to the extent of the value of the creditor s interest in the estate s interest in the property, or the amount subject to setoff. 6 a. A secured creditor is generally not required to file a proof of claim to preserve its status as a secured creditor. The secured lien will pass through the bankruptcy case unaffected regardless of whether a proof of claim is filed. b. However, when a pre-petition arrearage exists, the secured creditor may want to file a proof of claim to establish its claim for treatment in a Chapter 11 case. c. Similarly, where the claim is only partially secured, the creditor may wish to file a proof of claim to establish a claim for the unsecured portion of its debt. B. Requirements for filing a proof of claim The creditor or the creditor s agent must sign the proof of claim. 2. Copies of the documents evidencing the claim, such as evidence of perfection of any security interest claimed, must be attached to the proof of claim. 3. The bar date establishes the date by which proofs of claim must be filed against the estate. The bar date is similar to a statute of limitations and must be strictly observed. a. For non-governmental creditors, claims must be filed within 90 days after the first date set for the meeting of creditors. b. The bar date for governmental claims is 180 days after the date of the order for relief. 4. In Chapter 11 cases, the court normally fixes the bar date for filing proofs of claim and notice of such deadline must be given to all creditors and parties in interest. 5. A creditor may seek leave for an extension of time to file a late proof of claim due to inadvertence, mistake, or carelessness amounting to excusable neglect as well as due to intervening circumstances beyond the creditor s control. 8 6 See 11 U.S.C. 506(a)(1). 7 See Fed. R. Bankr. P See Fed. R. Bankr. P. 9006(b). 2
5 C. Common Mistakes. 1. Failure to attach supporting documentation. Bankruptcy Rule 3001(c) requires that evidence of all claims based on a writing be filed with the proof of claim. 2. Failure to provide proof of perfection of security interest. The type of proof required depends upon the perfection requirements of a security interest in the underlying collateral. For example, the creditor should provide copies of certificates of title for motor vehicles and manufactured homes, a copy of the recorded deed of trust for real estate, and copies of the recorded UCC-1 financing statement(s) for security interests in other personal property. 3. Improper claim of priority status. Priority claims are paid before other claims, including certain taxes, wages, customer deposits, etc. As a result, creditors often claim priority status, regardless of whether they hold a legitimate priority claim. 4. Late filed claims. Claims filed after the bar date are typically disallowed. D. Objections to claims. 1. A party in interest, e.g., a debtor, trustee, etc., can object to a creditor s proof of claim. 2. The objecting party has the initial burden of presenting sufficient probative evidence to overcome the prima facie effect of a proof of claim. 3. Once the objecting party has provided sufficient evidence to place the claimant s entitlement at issue, the burden of proof then shifts to the creditor to establish the validity and amount of its claim. The claimant bears the ultimate burden of establishing a valid claim by a preponderance of the evidence. 4. Neither the Bankruptcy Code nor the Bankruptcy Rules establish an absolute deadline for filing an objection to a claim. 5. Objections must be made in writing. The objection, along with a notice of hearing, must be served on the creditor at least 30 days before a hearing on the objection. 9 E. Effect of filing a proof of claim. 1. A proof of claim supersedes the claim as scheduled by the debtor. 2. A claim is deemed allowed unless and until an objection is filed. 3. Only creditors holding allowed claims are entitled to vote on the confirmation of a Chapter 11 plan of reorganization. 9 See Fed. R. Bankr. P (a). 3
6 Take-away 4. A creditor must hold an allowed claim in order to receive a distribution under a Chapter 7 or a Chapter 11 case. 5. By filing a proof of claim, a creditor incurs some risk in that the creditor has submitted itself to the jurisdiction of the Bankruptcy Court with respect to the claim and any issues arising therefrom. In addition, there are perjury implications if a false claim is subscribed. Be certain to determine whether filing a claim is necessary, what type of claim to file, the deadline to file a claim, and what supporting documentation should be attached to the proof of claim. Preparing and filing a proof of claim is usually inexpensive and preserves a creditor s right to a distribution from the debtor s estate and to vote to accept or reject a debtor s plan of reorganization in a Ch. 11 case. Objections to your proof of claim may be filed. However, such objections can typically be resolved informally between the creditor and the debtor. If a party in interest does not object to your proof of claim, then the claim is deemed allowed and subject to appropriate distribution. III. Special Vendor Claims, Including Reclamation A. Purpose. Generally, reclamation is a means for vendors to retrieve their goods delivered pre-bankruptcy to a debtor or to recover the value of such goods. B. Expansion of reclamation claims. As a result of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ( BAPCPA ), a vendor s reclamation rights have been expanded. Vendors now have two types of reclamation claims against a debtor: 1. Reclamation claim pursuant to 546(c) of the Bankruptcy Code. A vendor can make a written demand for the return of goods that: (i) were sold to the debtor in the ordinary course of the seller s business, (ii) which goods the debtor had received while insolvent, and (iii) which goods were received within 45 days prior to the date of the debtor s bankruptcy filing. 10 a. The vendor must make a written reclamation demand not later than 45 days after the date such goods were received by the debtor. If that 45-day period expires after the bankruptcy filing date, the vendor is given an additional 20 days to make a reclamation demand See 11 U.S.C. 546(c)(1). Prior to BAPCPA, the look-back period for reclamation claims was 10 days, not See 11 U.S.C. 546(c)(1). 4
7 b. Whether or not a vendor chooses to make a reclamation demand, a vendor still possesses the right to file an administrative priority claim pursuant to Section 503(b)(9) of the Bankruptcy Code Administrative claim under 503(b)(9) of the Bankruptcy Code. Post- BAPCPA, a vendor is entitled to file an administrative priority claim for certain goods sold to and received by the debtor before the petition date. Section 503(b)(9) provides, in pertinent part: See 11 U.S.C. 503(b)(9).... (b) After notice and a hearing there shall be allowed, administrative expenses... including... (9) the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor s business. a. The significance of a 503(b)(9) claim for goods is that such claim is afforded administrative priority status, which has to paid in full (i.e., dollar for dollar) and represents a significant expense of a creditor s recovery rights. b. Administrative priority claims are paid ahead of general unsecured claims and must be paid in full prior to or upon the confirmation of a debtor s Chapter 11 plan. C. Issues relating to 503(b)(9) claims. 1. Burden of proof. The vendor has the burden of proving all elements of its 503(b)(9) claim and that the claim qualifies for administrative priority status What qualifies as goods. The Bankruptcy Code does not provide a definition for goods. In a recent decision, a 4th Circuit Bankruptcy Court held that the Uniform Commercial Code s definition of goods should apply in the 503(b)(9) context. 14 a. Article 2 of the UCC definition of goods : all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale and things in action. Goods also include the unborn young of 12 See 11 U.S.C. 546(c)(2). 13 See Ford Motor Credit Co. v. Dobins, 35 F.3d 860, 866 (4th Cir. 1994); see also, In re Goody s Family Clothing, Inc., 401 B.R. 131, 137 (Bkrtcy. D. Del. 2009); see also, In re Plastech Engineered Products, Inc., 2008 WL at *2 (Bkrtcy. E.D. Mich. 2008). 14 See In re Circuit City Stores, Inc., 2009 WL at *3-4 (Bkrtcy. E.D. Va. 2009). 5
8 animals, growing crops and things attached to realty that can be severed from such realty (e.g., minerals, timber, oil, gas, etc.). 15 b. Items not considered goods : i. Electricity; ii. Advertising; iii. Repackaging apparel, etc. 3. Goods vs. Services. What happens when a vendor provides a debtor with both goods and services? Is the vendor entitled to an administrative expense claim under 503(b)(9)? a. Example: Vendor provides routine inspection and repair of its customer s cruise ships, which services include supplying expensive parts to repair or maintain such ships. 16 b. Predominant purpose test. The Bankruptcy Court in the Circuit City case recently ruled that when dealing with a hybrid transaction of goods and services, courts should apply the predominant purpose test to determine whether a vendor has a 503(b)(9) claim or an unsecured claim. Essentially, the court stated that it must: examine the transaction to determine whether the sale of goods predominates... whether their predominant factor,... is the rendition of a service, with goods incidentally involved (e.g. contract with artist for painting) or is a transaction of a sale, with labor incidentally involved. In re Circuit City Stores, Inc., 2009 WL at *5. If the Bankruptcy Court determine that a vendor s hybrid transaction with the debtor was predominantly for services rather than goods, the vendor does not have a valid 503(b)(9) claim. Conversely, if the predominant purpose of the transaction was for the sale and delivery of goods to the debtor, the vendor does have a cognizable 503(b)(9) claim. 4. Whether goods are received by the debtor. The word received is also not defined in the Bankruptcy Code. Some courts have held that the goods must be physically received by the debtor. 17 Take-away 15 See U.C.C (1). 16 See Princess Cruises, Inc. v. General Electric Co., 143 F.3d 828 (4th Cir. 1998). 17 See In re Pridgen, 2008 WL at *11012; see also, In re Plastech Engineered Products, Inc., 2008 WL at *
9 Be aware of problem customers early on (i.e., before bankruptcy is filed) as there may be ways to avoid reclamation issues entirely, such as by tightening up credit terms. Pay attention to the bankruptcy filing date - this is the key period from which calculations for reclamation claims and administrative claims are made. Identify and segregate invoices for goods shipped during the 45 days prior to bankruptcy (reclamation period) and do not delay in sending a reclamation demand. If your goal is to recover an administrative expense claim, present such a claim early on in the case, and certainly before any bar date. Determine whether your transaction with the debtor was a hybrid transaction for goods and services determine whether you are entitled to a 503(b)(9) claim under the predominant purpose test used in the 4th Circuit. IV. Potential Vendor Liability. A. Avoidable or voidable transfers. Certain transfers made by a debtor to a creditor can be cancelled by either a debtor or a trustee, resulting in the return of property or the value of the same to the bankruptcy estate. The following are some types of transfers that are avoidable or voidable under the provisions of the Bankruptcy Code. B. Preferential Transfers. 1. A preferential transfer is: a. A transfer by the debtor of its interest in property; b. to or for the benefit of a creditor; c. for an antecedent debt owed by the debtor; d. where such transfer was made within: i. 90 days prior to the debtor s filing of its bankruptcy petition; ii. Or between 90 days and one year prior to the petition date if such creditor was an insider at the time of the transfer; e. which transfer was made while the debtor was insolvent; and f. enabled the creditor to receive more than the creditor would have received in a Chapter 7 bankruptcy case See 11 U.S.C
10 Take-away 2. Defenses/Exceptions. Just because a transfer is made within a 90-day period does not mean that the transfer is automatically an avoidable preferential transfer. Numerous defenses/exceptions exist to preference actions, including: a. Transfers made in the ordinary course of business ; b. Substantially contemporaneous exchanges ; c. Where the creditor extends new value to the debtor in exchange for a preferential payment; and d. Transfers aggregating less than $5,475 (in non-consumer cases only). In most large Chapter 11 cases, preference demand letters are sent to all parties which received payment in the 90-day period prior to bankruptcy. This does not mean that a preference has occurred. As noted, more often than not, defenses exist. If a bankruptcy is filed and you or your entity received significant payments during the 90-day preference period, work back from the bankruptcy filing date and assemble an invoice history between the parties for both the 90-day preference period and a reasonable period of time prior to the preference period to determine whether the ordinary course of business defense exists. If there is preference exposure, don t assume that thousands of dollars need to be spent on legal fees - often preference cases can be settled relatively quickly and easily. Finally, use caution when doing business with companies on the brink of filing bankruptcy. You may consider asking for prepayment of C.O.D. payment, security interests, or personal guaranties and, most importantly, make sure that the delay between invoicing and payment remains consistent. C. Other types of avoidance or voidance actions U.S.C. 548: Avoidance of fraudulent transfers or obligations. A trustee can avoid a transfer by a debtor of its interest in property, or an obligation incurred by the debtor, that was made or incurred within 2 years before the petition the petition date, if the debtor voluntarily or involuntarily: a. made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or b. received less than a reasonably equivalent value in exchange for such transfer or obligation; and 8
11 i. the debtor was insolvent on the date that the transfer or obligation occurred, or became insolvent as a result of such transfer or obligation; ii. was engaged or about to be engaged in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; iii. intended to incur debts that would be beyond the debtor s ability to pay as those debts matured; or iv. made the transfer or incurred the obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business U.S.C. 542: Turnover of property to the estate. In certain circumstances, an entity, other than a custodian, 19 in possession, custody, or control, during the case, of property that the trustee may use, sell, or lease, or that the debtor may exempt under the provisions of the Bankruptcy Code, shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate. 3. Va. Code 55-80: Void fraudulent acts; bona fide purchasers not affected. Every gift, conveyance, assignment or transfer of, or charge upon, any estate, real or personal, every suit commenced or decree, judgment or execution suffered or obtained and every bond or other writing given with intent to delay, hinder or defraud creditors, purchasers or other persons of or from what they are or may be lawfully entitled to shall, as to such creditors, purchasers or other persons, their representatives or assigns, be void. a. This section shall not affect the title of a purchaser for valuable consideration, unless it appears that he had notice of the fraudulent intent of his immediate grantor or of the fraud rendering void the title of such grantor. b. When a bankruptcy petition is filed, the trustee stands in shoes of creditors protected by Virginia law which provides that any gift, conveyance, assignment, or transfer of any real or personal property with intent to hinder, delay, or defraud creditors is void as to those creditors A custodian is defined as: (a) a receiver or trustee of the debtor s property, who was appointed in a case not under this title of the Bankruptcy Code; (b) an assignee for the benefit of the debtor s creditors; or (c) a trustee, receiver or agent under applicable law or contract, that is authorized to take charge of the debtor s property to enforce a lien or for the general administration of the property for the benefit of the debtor s creditors. See 11 U.S.C. 101(11). The trustee may initiate a separate turnover action against a custodian pursuant to 11 U.S.C See 11 U.S.C. 544(b); see also, In re Yost, 47 B.R. 697 (Bankr. W.D. Va. 1985). 9
12 Take-away c. There is no statute of limitations with respect to fraudulent conveyances. However, a trustee or debtor must commence suit by the earlier of: i. The later of (A) 2 years after the entry of the order for relief; or (B) 1 year after the appointment or election of the first trustee ; or ii. The time the case is closed or dismissed Va. Code 55-81: Voluntary gifts, etc., void as to prior creditors. Every gift, conveyance, assignment, transfer or charge which is not upon consideration deemed valuable in law,... by an insolvent transferor, or by a transferor who is thereby rendered insolvent, shall be void as to creditors whose debts shall have been contracted at the time it was made, but shall not, on that account merely, be void as to creditors whose debts shall have been contracted or as to purchasers who shall have purchased after it was made. Even though it is decreed to be void as to a prior creditor, because voluntary..., it shall not,... be decreed to be void as to subsequent creditors or purchasers. a. The statute of limitations for bringing a claim under is 5 years from recordation or if not recorded, within 5 years from the time the conveyance should have been discovered. 22 b. However, the Bankruptcy Code extends the above statute of limitations to the later of: 1. The end of the 5 year statute of limitation under Virginia law, including any suspension of such period occurring on or after the commencement of the bankruptcy; or 2. 2 years after the order for relief. 23 Other types of avoidance and voidance actions are available to creditors/trustee/debtor outside of a preferential transfer claim (11 U.S.C. 547) and fraudulent transfers (11 U.S.C. 548). When dealing with a debtor that is insolvent or on the verge of insolvency, be sure that any transaction is conducted at arm s length and that fair consideration for such transfer is given to the debtor. 21 See 11 U.S.C See Va. Code See 11 U.S.C
13 V. Personal Guaranties. Absent a bankruptcy court order extending the automatic stay to a non-debtor guarantor (which is rare), you are free to pursue claims against guarantors after the company/primary obligor has filed bankruptcy. Take-away Review your guaranty documents. Determine which entity or entities have filed bankruptcy. Bear in mind that guarantors of closely held companies often file personal bankruptcies after the debtor-company files for bankruptcy protection. 11
14 VI. Glossary of Terms. 24 Antecedent debt Refers to a debt where the debtor is obligated to pay you for goods or services after you have already delivered the goods or provided the services to the debtor. The date on which a payment actually occurs determines whether an antecedent debt exists. Example: The debtor issues a check to you before delivery of goods. You then deliver the goods. The check subsequently bounces. Thus, no payment occurred prior to delivery, resulting in an antecedent debt owed by the debtor to you. Automatic Stay - An injunction that automatically stops lawsuits, foreclosures, garnishments, and all collection activity against the debtor the moment a bankruptcy petition is filed. 25 Avoidable or Voidable - Used to refer to a transfer (see definition below) from the debtor to you that can be cancelled in bankruptcy. Once a transfer is cancelled, you must return what you received or the value of what you received in the transfer. Chapter 7 - The chapter of the United States Bankruptcy Code (the Bankruptcy Code ) that provides for the liquidation (see definition below) of a business in bankruptcy or of an individual s assets by a Court appointed trustee. Chapter 7 Trustee - A person appointed by the U.S. Trustee (see definition below) as the representative of the debtor s estate, for purposes of recovering, preserving, liquidating, and distributing the debtor s assets. The Chapter 7 Trustee is not a government employee, but is typically a lawyer or an accountant. Chapter 11 - The chapter of the Bankruptcy Code frequently referred to as a reorganization bankruptcy. A bankruptcy filed under Chapter 11 is typically used to reorganize a business, i.e., a corporation, sole proprietorship, or partnership, although it has been used often as a vehicle to liquidate assets. Individuals may also file a Chapter 11 bankruptcy petition. Chapter 13 - The chapter of the Bankruptcy Code providing for adjustment of debts of an individual with regular income. A Chapter 13 bankruptcy allows a debtor to keep property and pay debts over time, usually three to five years. Debtor - Person or business entity who filed for bankruptcy protection. Debtor in possession - A debtor that remains in control of its business operations during the bankruptcy. If a Chapter 7 Trustee is appointed, he takes over for the debtor, and the debtor is no longer a debtor in possession. 24 In the following definitions, you refers to the supplier, vendor, or other creditor who provided goods or services to a customer. Debtor refers to a customer that received such goods or services and later filed for bankruptcy. 25 See 11 U.S.C
15 Debtor s estate - Everything that the debtor or debtor in possession has rights in or to at the time of filing for bankruptcy and during bankruptcy. The debtor does not have to own something for it to be part of the debtor s estate. For example, if the debtor has a right to use equipment under lease, the right to use that equipment is in the debtor s estate. Insider - For an individual debtor, an insider is (a) any relative of the debtor, (b) a general partner of the debtor, (c) a partnership in which the debtor is a general partner, or (d) a corporation of which the debtor is a director, officer, or person in control. For a debtor-corporation, an insider is a (a) director, officer, or person in control of the debtor, (b) a partnership in which the debtor is a general partner, (c) a general partner of the debtor, or (d) a relative of a general partner, director, officer, or person in control of the debtor. Insolvent - The debtor habitually is unable to pay its bills on time or the debtor s liabilities exceed the value of its assets on its balance sheet. Liquidation - The sale of a debtor s property/assets by the debtor or a Trustee, with the distribution of the sale proceeds to creditors. Meeting of Creditors - Pursuant to Section 341 of the Bankruptcy Code, a Chapter 7 Trustee or a U.S. Trustee of a bankruptcy case holds a public meeting of creditors (a/k/a a 341 meeting ), of which the debtor s creditors and parties-in-interest are given notice. At the 341 meeting, the Trustee and any creditors present may question the debtor under oath regarding the debtor s acts, conduct, property, and the administration of the case. Payment - Anything of value that the debtor transfers to you as payment for its debt owed to you. Example: money, services, or the offsetting of an amount that you owed to the debtor prior to the bankruptcy. Petition Date - The date on which the debtor files its bankruptcy petition. Preference period - The 90-day period (or one-year if you are an insider of the debtorcompany) prior to the date the debtor filed its bankruptcy petition, which period ends on the date of the filing. Pre-petition - The period of time prior to the petition date of a bankruptcy. Post-petition - The period of time after the petition date of a bankruptcy. Proof of Claim - A proof of claim is a written statement (which may include supporting documentation) filed by a creditor, which sets forth a creditor s claim against the debtor See Fed. R. Bankr. P For the official proof of claim form used by bankruptcy courts, see 13
16 Transfer - The conveyance of anything of value (whether or not tangible) from the debtor to you. A payment is just one type of transfer. There are many types of transfers. Example: The debtor gives you a security interest in its inventory (even inventory you provided). The giving of that security interest is considered a transfer. Also, if the debtor returns to you goods it cannot pay for, that return is a transfer. United States Trustee or U.S. Trustee - This is a Department of Justice attorney who oversees the daily administration of all bankruptcy cases. He or she is also responsible for ensuring compliance with applicable laws and procedures and identifying and investigating bankruptcy fraud and abuse. In addition, the U.S. Trustee imposes certain requirements on a debtor in possession, e.g., reporting its monthly income and operating expenses, establishing new bank accounts, and paying current employee withholding and other taxes. 14