by Scott Schuster, Esq.

According to a recent article in the New York Times, individual and corporate bankruptcies are at a five-year high. As a creditor, here are three things to keep in mind during these difficult financial times:

1)      With the increase in “under water” secured creditors, unsecured creditors are receiving less and less on their claims through bankruptcy. It may be a good idea to have a backup if a customer fails to pay its bills. Letters of credit, lien rights, and partial payments on delivery are all ways to mitigate the damage that can be caused by a failing customer’s bankruptcy.

2)      Just because a customer has always paid its bills in the past does not mean it will do so in the future. Increasingly, even healthy companies are struggling financially. Keep an  eye on credit terms that you extend to all of your customers, both big and small. It never hurts to reevaluate the terms on which you extend credit to your largest customers. If you conduct a credit worthiness analysis and find something troubling, it may cause you to take additional action to protect yourself from unpaid bills. If the credit check reveals no problems, at least you can sleep soundly knowing that those customers are healthy enough to pay their bills in the future.

3)      Preference actions are on the rise. Debtors and trustees are looking to preference actions as a means to fund distributions to unsecured creditors. This means creditors should be aware of the defenses to those actions and should review their “danger” clients to make sure that payment times are not getting too high. Ideally, payments should be made within (or very close to) payment terms (“NET 30,” etc.). If customers are not doing so, it may be prudent to limit the amount of credit that you extend now to protect yourself from a preference action in the future.

by Scott Schuster, Esq.

Unfortunately, the Code does not require that the administrative claim be paid in full immediately after the Court allows the claim. Instead, the Code only sets the relative priority of the claim.  In Chapter 11, a requirement for the confirmation of a Plan is that administrative expense claims be paid “in full and in cash.” If the case is ultimately declared “administratively insolvent” – i.e. the debtor does not generate sufficient cash to pay its administrative claims – then 503(b)(9) creditors will probably not receive the full amount of their claims.

While the court can order immediate payment of these claims, they often decline to do so. The courts have tended to be very debtor friendly on this issue. In two recent cases, In Re Bookbinders and In Re Global Home Products, LLC, creditors attempted to force immediate payment of 503(b)(9) claims. In both cases, creditors urged the court to order immediate payment of the claims, arguing that there may not be enough assets left at the end of the bankruptcy to pay the 503(b)(9) claims in full. In both cases, the courts’ reasoned that the Code did not explicitly provide for immediate payment. The courts in both cases denied the creditors’ request for immediate payment of their 503(b)(9) claims. Unfortunately, in the Global Home Products case, 503(b)(9) creditors ultimately received less than 50 percent of their claims under the debtor’s Plan.

While a 503(b)(9) creditor appears to face an uphill battle, it is not all bad news. In fact, section 503(b)(9) has greatly increased the potential for recovery for large numbers of unsecured creditors nationwide. Notwithstanding the difficulties of allowance and payment that 503(b)(9) creditors face, they stand in a better position than a general unsecured creditor. Section 503(b)(9) claims are given the same priority status as the debtors’ attorneys’ and other professionals’ fees. In the grand scheme of the bankruptcy system, this is about the best position in which a trade creditor can sit.

Since many 503(b)(9) motions are lightly contested, they can be handled by experienced creditors’ rights counsel at a modest price. In fact, a valid 503(b)(9) claim is often stipulated to by the debtor early in the case. Often the debtor will agree to allow the claim in full, if the creditor agrees to forego payment until a plan can be confirmed. This system benefits all parties because if all 503(b)(9) creditors demanded immediate payment in full, many debtors would not have sufficient cash flow to meet those demands, and would terminate operations shortly after entering bankruptcy. Since debtors rarely enter bankruptcy with significant cash reserves, such an outcome would likely result in 503(b)(9) creditors receiving far less than 100 percent of their claims.

If a creditor is willing to accept a reduced amount on its 503(b)(9) claim, then it should consider “claim traders” – companies that purchase bankruptcy claims from creditors. Claim traders are often very interested in 503(b)(9) claims and, depending on the circumstances of the particular debtor and its prospects for reorganizing, are often willing to pay a very large percentage of the claim.

by Scott Schuster, Esq.

Since clients ask about this all the time, I thought it would be a good time to give a quick refresher on 20-day claims and briefly discuss how creditors are faring in Bankruptcy cases when it comes to 20-day claims.

Under most state laws, a credit seller has the right to “reclaim” goods (get them back or get a lien for the value), from a defaulting buyer. Most state laws require a reclamation notice be given within 20 days of the delivery. Some require as few as 10 days. Recognizing the difficulty with these short timeframes, earlier changes to the Bankruptcy Code enabled creditors to give notice within 20 days after the bankruptcy filing. The right still only covered deliveries in the 10 days before the bankruptcy.

The 2005 amendments expanded the notice rights to provide that, when goods are sold to a debtor within 45 days of a bankruptcy filing, the seller has a right to reclaim those goods, so long as the seller gives notice within the first 20 days of the bankruptcy. Failure to provide this notice results in a waiver of the reclamation right. Sellers often miss this “notice deadline” and lose their right to reclaim their goods. Further, because the rights of a reclaiming seller are subject to the rights of a prior, properly perfected lienholder on the type of goods sold, this reclamation right is often illusory. Section 503(b)(9) was inserted into the Bankruptcy Code as a way of offering relief to sellers of goods whose reclamation right is rendered meaningless - either by failing to give the required notice or because of a prior lienholder’s rights.

Creditors have had mixed results in the first three years following the addition of section 503(b)(9) to the Code. For starters, obtaining an allowed administrative claim requires an upfront investment. The creditor must do one of two things: 1) get the debtor to agree to allow the 503(b)(9) claim; or, 2) if the debtor refuses to agree, file a motion with the court. This means that the creditor often has to hire an attorney and expend resources upfront.

More importantly, debtors will often challenge the 503(b)(9) claim in an attempt to get the creditor to negotiate the amount. Debtors will often claim that they received the goods outside of the required 20-day window. This forces the creditor to show evidence, through supporting documentation and testimony. Debtors sometimes take this position solely as a negotiation tactic. Debtors know that it will cost the creditor valuable time and money to litigate the case and that the creditor may be willing to settle for less in order to avoid litigation.

Be sure to check back for A Refresher on 503 (b)(9) “20-Day Claims” Part 2

By Scott E. Schuster, Esq.

I read this article in the Pittsburgh Tribune Review:(http://www.pittsburghlive.com/x/pittsburghtrib/news/s_672744.html) and it got me thinking about state oversight of financially distressed municipalities. Under Pennsylvania state law (commonly referred to as Act 47), municipalities in the Commonwealth are not eligible to file for federal bankruptcy protection without first implementing a financial recovery plan overseen by a state appointed board.

This approach to municipal reorganization stands in stark contrast to the federal bankruptcy code. Under the state law, a distressed municipality attempts to cut expenses and increase revenue in an effort to pay off its debts. The result is often a myriad of political “quick-fixes,” such as new taxes, elimination of social programs, and the sale or lease of municipal assets, such as parking garages.

The state system lacks two significant components that the bankruptcy code provides to distressed companies or municipalities to assist in reorganization. First, Act 47 does not allow for the discharge of debts. Instead, Act 47 requires that the municipality attempt to restructure certain debts or pay them off with a lump sum. Of course, financially distressed municipalities usually lack the cash flow to make lump sum payments on large debts. Similarly, Act 47 does not allow municipalities to cancel unfavorable contracts. The inability to discharge debts and cancel unprofitable contracts would have proven fatal to several big companies that have emerged from Chapter 11 Bankruptcy over the past two decades; GM, US Airways, and the Pittsburgh Penguins, just to name a few.

Second, the Bankruptcy Code gives corporate debtors the ability to “cram down” union contracts for the best interest of all creditors. In other words, the Bankruptcy Code allows union contracts to be reasonably restructured so that the company’s employees do not sap all of the company’s future revenue, leaving nothing for creditors. Act 47 system has no such provision and, in fact, relies exclusively on the political leaders of the municipality - often unions’ closest allies - to enact changes in applicable collective bargaining agreements. Such a system is destined to fail and has done so, repeatedly.

The Tribune Review reports that 25 municipalities have entered Act 47 oversight but only 6 have escaped. Proof of Act 47’s shortcomings can be seen right here in Pittsburgh, which was forced into this state form of receivership in 2004 and has spent nearly 6 years attempting to right its financial ship, but to no avail. As of this writing, Pittsburgh’s employee pensions have only 30% of the money necessary to fund future payouts. Unions have refused to agree to reduce their benefits and the politicians responsible for forcing such concessions lack the political backbone to press for change. In short, politics has taken over and, 6 years later, the City is still on the verge of bankruptcy. How has Act 47 helped the City of Pittsburgh? It hasn’t.

With the economic downturn and lack of revenue, more and more municipalities in Pennsylvania are at risk of falling into Act 47 protection. Those municipalities are staring at five to ten years of financial purgatory, during which no meaningful changes take place and bankruptcy continues to loom on the horizon. I say let Pennsylvania municipalities file bankruptcy.

by Scott E. Schuster, Esq.

by Shawn P. McClure

A couple of months ago, I attended a presentation by a well known trial attorney.  He opened the seminar by stating that he had never represented a Plaintiff/Creditor in a breach of contract action.  Given the fact that the audience consisted of creditors’ rights attorneys, collection agencies and credit managers, this statement raised some eyebrows. 

This gentleman was quick to qualify this statement by saying that he has tried thousands of “broken promise” cases, but never a breach of contract case.  His point was that it is important to remember that these breach of contract cases (i.e. broken promises) are being heard and decided by people just like you and me.  As such, it is important not only to keep things as simple as possible, but to make sure that we don’t exclude the human element to such cases.

I think that this lesson translates to all stages of any collection effort.  It is something that everyone in the credit industry needs to remember.  From the initial telephone call to your Debtor, through the closing argument your attorney makes during a jury trial, all that is at issue is a broken promise.  The key is conveying to those involved, the Debtor, Debtor’s Counsel, Judge, Jury, etc., the simplicity and humanity of the situation.

Webster’s Dictionary defines a “promise” as, “a declaration that one will do or refrain from doing something specified.”  It is as simple as that.  Once you learn to communicate this characterization of your claim to the Debtor or their attorney, your successful collections will undoubtedly increase.  Just remember, don’t break any promises of your own.  If settlement discussions break down and you have threatened legal action, be sure to act promptly by contacting your creditors’ rights attorney.”  

by Scott Schuster, Esq.

There is nothing more frustrating that having one of your biggest customers file for bankruptcy, leaving your company holding a large unpaid debt, and then to be sued later for a “preference.” Clients often ask us: “I was not getting preferential treatment by the debtor, why am I being sued for a preference?” The answer to that question lies at the root of the supposed purposes of preference statutes in the bankruptcy code.

Congress enacted preference statutes for two reasons: 1) to prevent creditors from “dismembering” a struggling debtor during the debtor’s slide into insolvency; 2) to promote equality of distribution (of debtor’s assets) amongst debtor’s creditors.

The former is based on the premise that creditors typically realize when a debtor is struggling financially. Concerned that they debts may not be paid if the debtor enters bankruptcy, those creditors threaten the debtor (with lawsuits) until the debtor agrees to pay the debt. The debtor, at a time when cash flow is already a major problem, pays the debt in hopes of staying afloat by avoiding legal expenses.

If multiple creditors take the same action, the debtor’s limited assets are haphazardly distributed amongst a few select creditors to the detriment of debtor’s other creditors. In the meantime, debtor is stripped of its operating capital and forced into bankruptcy, leaving most of its creditors with unpaid debts.

In theory, the threat of bankruptcy preference actions may prevent creditors from demanding payment once a debtor is in financial turmoil. In reality, the creditor takes whatever action it would normally take and then hopes that more than ninety days pass before the bankruptcy is filed.

The second foundation for preference statutes is equally dubious. More often than not, preference payments are made to unsecured creditors. When money is recovered through preference actions during the preference case, significantly less than 100% of that money is paid to unsecured creditors. Usually, a substantial portion of the recovered assets are paid to administrative creditors (i.e. those that provided goods and services after the bankruptcy was filed) and priority creditors (like taxing authorities and employees).

In fairness, preference actions usually benefit more creditors than they hurt. Again, more often than not, those receiving payments during the 90-days preceding the bankruptcy filing are less in number than creditors that did not receive such payments. Consequently, the end result of preference actions is usually some benefit to unsecured creditors as a whole, but often very little.

In any event, the dual aims of preference statutes described above are rarely achieved.

by Shawn P. McClure

“A quick question for all creditors out there. How many of you require a signature from your customers upon receipt of delivered goods? Better yet, how many of you actually deliver the goods that have been sold?

The more likely scenario is that delivery of your goods to customers is done via a “common carrier.” Generally, a common carrier is a third party business that exists for the transportation of goods and/or people. More specifically, I am referring to all of the goods that you, as a creditor, have sold and shipped to customers via FedEx or UPS.

In those cases, the customer receives the goods from the common carrier and signs for them. As we all know, this signature is often electronic. The common carrier then charges either your or the customer’s account for the shipping depending on the parties’ agreement, and business continues as usual.

Then the customer’s payments start coming late, then payments cease altogether. The customer ignores your demands for payment, and you decide to retain a creditors’ rights attorney.

Suit is filed, and your former customer, now a defendant, files a response denying that the alleged goods were ever received. Your creditors rights attorney provides you with a copy of the defendant’s response, and asks you to address the dispute regarding receipt of the goods.

Once your blood stops boiling and the cursing subsides, you respond that will simply contact the common carrier used, FedEX, and obtain copies of the signed delivery forms. However, your frustration continues to mount when you are told that your common carrier only retains records for a period of six months.

Therein lies the problem. By the time suit is filed and discovery is initiated, it is very likely that the common carrier you used for delivery of the goods has since purged their records in accordance with their own documentation retention system. Even if you were able to contact the common carrier and obtain copies of the documents, there are still a number of evidentiary hurdles present, such as hearsay, authentication and foundation.

One possible solution may be to implement a document retention process regarding signed delivery forms from common carriers into your regular business practices. This may allow you to take advantage of the “Business Records Exception” of evidence. This rule allows for the entry of certain documents, in this case the commone carrier signature documents, in cases where there is not a first hand witness, in this case the FedEx or UPS man, available to testify as to those documents. The rationale for the exception being that employees are under a duty to be accurate in observing, reporting and recording business facts, so that typical concerns regarding reliability of such third party documents are somewhat limited.

In order for a record to meet the requirements of the Business Records Exception, four general requirements must be met: 1) The record was made and kept in the course of a regularly conducted business activity; 2) It was the regular practice of the business activity to make the record; 3) The record was made at or near the time of the event that it records; 4) The record was made by, or from information transmitted by, a person with knowledge acting in the regular course of business.

While the implementation of such a system may seem like a troublesome task, once in place it could easily be maintained, and will allow you, as a plaintiff/creditor, to prove your case a lot easier.”

by Scott Schuster, Esq.

A recent article in the Pittsburgh Post-Gazette indicates that bankruptcies are once again on the rise. With the economy in a deep recession and unemployment hovering at over 10% with no end in sight, this comes as no surprise. As an attorney that practices almost exclusively in bankruptcy, here are some of my observations about bankruptcies in the past year.

1) Increasingly, secured creditors find themselves “under water,” leaving little to nothing for unsecured creditors through traditional bankruptcy reorganization. In these trying times, 503(b)(9) “20-day” claims are extremely valuable and should always be analyzed before closing a collection file after a customers’ bankruptcy. Don’t assume that you’ll get paid through a plan of reorganization.

2) Many chapter 11 debtors are failing to reorganize due to the lack of “exit” financing in the financial market. This means that creditors doing business with chapter 11 debtors should keep credit terms tight and may want to consider having legal counsel keep an eye on the bankruptcy proceedings. Often times, legal counsel can spot a failure months in advance, allowing creditors to get paid before the debtor is forced to liquidate.

3) More and more, debtors and trustees are looking to preference actions as a means to fund distributions to unsecured creditors. This means creditors should be aware of the defenses to those actions and should review their “danger” clients to make sure that payment times are not getting too high.

4) Fraud seems to have become more prevalent than ever before. In the past, debtors relied on easy credit to fund cash flow shortages and business operations. As debtors face tight credit markets, the pressure to “cut corners” increases. As a result, we’re seeing an increase in falsified financial reports, falsified credit applications, and fraudulent billings. Creditors should be on the look-out for this behavior. Since debts obtained by fraud are not dischargeable through bankruptcy, if a creditor discovers that a debtor has committed fraud in obtaining a debt, the creditor should consider a “nondischargeability action” as a way of maintaining their ability to pursue those debts after bankruptcy.

5) More “good” companies are in bankruptcy than ever before. Previously, with some exceptions, a corporate debtor was in bankruptcy due to one of three things: poor management, a poor business model, or a failing industry. Now, we’re increasingly seeing well run companies in struggling industries (construction, steel, auto) falling victim to difficult economic times. It’s important to keep an eye on the credit terms you extend to even your best customers, as no one seems to be immune from this economy.

by Scott Schuster

Typically, the central purpose of filing a bankruptcy is to “discharge” all or most of the debtors’ debts. A bankruptcy “discharge” releases the debtor from personal liability for certain specified types of debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. The discharge is a permanent order forever prohibiting the debtor’s creditors from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts. Generally, excluding cases that are dismissed or converted, individual debtors receive a discharge in more than 99 percent of chapter 7 cases.

However, the Bankruptcy Code sets forth an extensive list of debts that are nondischargeable. Unfortunately, nondischargeability is not automatic – a creditor that holds such a debt must file a complaint with the Bankruptcy Court seeking to have the debt declared nondischargeable. A nondischargeability complaint must usually be filed within about sixty (60) to ninety (90) days after the debtor files his or her bankruptcy petition. 

The largest category of nondischargable debts are those incurred through: 1) false pretenses, a false representation, or actual fraud; or 2) obtained through the use of a statement in writing, which is materially false regarding the debtor’s financial condition, and on which the creditor reasonably relied.

As one would imagine, the terms “false pretenses, false representations, or actual fraud” can encompass many types of dishonest behavior. An important consideration the court will make is whether the debtor intentionally and knowingly made the false/fraudulent representations. To except a debt from discharge under this section, the false representations giving rise to the debt must have been knowingly and fraudulently made. In other words, the failure to pay a debt is not sufficient, even if there is no excuse for the failure. The debtor has to incur the debt knowing that he will not be able to pay the debt, and knowing that the statements he is making to the creditor about his ability and intention to pay are untrue.

A creditor alleging fraud has the burden of proving that the debtor knew that any stated intention to repay was false and that the debtor nevertheless deliberately incurred the debt. The fact that the debtor was insolvent does not by itself provide a sufficient basis for inferring the debtor’s intent. A debtor’s honest belief that a debt would be repaid in the future, even if in hindsight found to have been very unrealistic, negates any fraudulent intent.

Use of a materially false writing concerning the debtor’s financial position comes up often in transactions that required the debtor to complete a credit application. On most credit applications, lenders will ask a debtor to list their monthly income and their current outstanding debts. Lenders then use this information to determine the debtor’s “debt-to-income” ratio. If the debtor falsely inflates their income, or omits certain debts, then the debt-to-income is inaccurate. If the court determines that the creditor reasonably relied upon the credit application in making the loan, then the debt is nondischargeable.