by Shawn P. McClure, Esq.

While I subscribe to the belief that a secured lien holder should always know the location of its collateral, I understand that is essentially impossible to practice. Which is why a secured lien holder may some day find themselves in a position where they find their collateral in the possession of a third party. Often that third party is a garage looking to be paid for repairs, towing or storage with respect to the collateral.

Under Pennsylvania law, the secured lien holder is generally on the hook for repairs and towing charges. The theory being that the secured lien holder receives any benefit bestowed upon the collateral. However, a dispute often arises over storage fees. Particularly, where a garage stores the collateral and then makes no effort to inform the secured lien holder of the collateral’s location.

With typical charges of $25.00-$35.00 per day, these storage fees can quickly accumulate. A garage is entitled to any storage fees incurred after the secured lien holder gave “consent” to storing the collateral. Obviously, if the secured lien holder gave express consent to store the collateral, there is no issue. The problem arises in instances of implied consent. Implied consent will be found when the garage has sent notice to the secured lien holder that they have the collateral and the secured lien holder does not pick up the collateral.

However, most problems arise when express consent is not given and notice is not sent. The secured lien holder after months of contacting the Debtor about delinquent payments finally hears from the Debtor that the collateral has been at the local garage for months. So what does a secured lien holder do?

1. Immediately contact the garage and find out exactly what amount of money they are demanding. Obtain a break down of the charges identifying what is for repairs, towing, storage, etc. Also, find out what they are charging per day to store the collateral.

2. Immediately make a reasonable offer, in writing, to the garage to resolve the matter. Pennsylvania case law provides that if a garage declines a reasonable offer to a secured lien holder, then the garage cannot seek any storage fees if it is later found consent to storage did not exist.

3. It is usually best to settle. However, if the garage is unreasonable, then immediate legal action should be taken by contacting your creditors’ rights attorney.

By Jennifer Tis, Esq.

Undoubtedly, social networking sites such as Facebook will change the face of the legal practice in a number of ways, some foreseeable, some not. Already, Facebook has been used in criminal investigations, used for “cyber-bullying” and has been the subject of privacy disputes due to school administrations’ use of Facebook to suspend students for activities such as underage drinking.
Facebook has also been a sought-after source of information for attorneys involved in active litigation in a variety of areas of the law. Whether it’s a civil or criminal matter, a case can often be expeditiously closed due to a few posts made by either the Plaintiff or Defendant on Facebook or other social networking site. Often times, however, an individual’s public posts may not reveal much in regards to an active litigation matter though the individual’s private posts and messages may disclose much more. The question is, how can an attorney ethically gain access to the private information located within an opposing party’s social network site?
It is tempting to have another individual, such as a friend, secretary or paralegal, send a “friend request” to an opposing party in order to gain access to the information that is not made public on their Facebook page. To do so, however, would violate a number of the Pennsylvania Rules of Professional Conduct, including, but not limited to, Rule 5.3 (Responsibilities Regarding Nonlawyer Assistants) and 8.4 (Misconduct).
Rather, there are a few non-binding cases out there that suggest that private information from an individual’s social network site may be obtained through discovery requests. One case in particular comes from Jefferson County, Pennsylvania and illustrates what may be Pennsylvania’s emerging view toward discovery and social networking sites. In McMillen v. Hummingbird Speedway, the Plaintiff claimed that he was injured when the Defendant rear-ended him during a cool down lap after a stock race.
After the Plaintiff posted information on the public portion of his Facebook and MySpace accounts which indicated that he may not actually be injured, the Defendant requested Plaintiff’s usernames and passwords to his social network accounts in Interrogatories. The Plaintiff objected to this request and the Defendant filed a Motion to Compel. The Court granted Defendant’s Motion and ordered the Plaintiff to produce his usernames and passwords to his Facebook and MySpace accounts to Defendant’s counsel, only (the Defendant, himself, was not permitted access to the accounts). The Court further ordered that the Plaintiff was prohibited from taking steps to alter or delete existing information or posts from his Facebook and MySpace accounts.
The Court stated: “Under Pennsylvania’s broad discovery rules, as long as it is relevant to the litigation, whether directly or peripherally, a party may obtain discovery regarding any unprivileged matter. Pa.R.C.P. 4003.1.” McMillen v. Hummingbird Speedway, 2010 Pa.Dist. & Cnty. Dec. LEXIS 270, 2. “In this case, the Plaintiff asked the Court to recognize communications shared among his private friends on social network computer sites as confidential and privileged and thus protected against disclosure.” Id, at 3.The Court noted that Pennsylvania law does not favor evidentiary privileges “for they are in derogation of the search for the truth.” Id, (quoting) Hutchison v. Luddy, 414 Pa. Super. 138, 606 A.2d 905, 908-09 (Pa. Super. 1992) (quoting) Herbert v. Lando, 441 U.S. 153, 175, 99 S. Ct. 1635, 60 L. Ed. 2d 115 (1979).
The Court also pointed to the terms and privacy policies of both Facebook and MySpace stating that they “clearly express the possibility of disclosure” barring the Plaintiff from successfully maintaining that the element of confidentiality protects his Facebook and MySpace accounts from discovery. Id at 10.
The Court went on to state “whatever relational harm may be realized by social network computer site users is undoubtedly outweighed by the benefit of correctly disposing of litigation.” Id, at 11.
The fact that the Plaintiff first posted public information that was relevant to the matter and, therefore, suggested that additional relevant information may be located in the private sections of his Facebook and MySpace pages was clearly taken into account. Had he not made the public posts, I believe that the Court may have ruled differently.
Although this case is not binding, it may be an indication of what is to come from Pennsylvania Courts with respect to social networking sites and litigation. Will Pennsylvania adopt a narrow interpretation of confidentiality? Only time and additional ill-advised posts from plaintiffs and defendants will tell.

by Scott Schuster, Esq.

Many of you are familiar with preferences actions and the defenses to those actions. You may not be aware of fraudulent transfer actions. With the increasing rise in bankruptcy cases in which the main secured creditor is “under water,” bankrupt debtors and trustees are using preference actions as a primary means for collecting funds to distribute to unsecured creditors. However, since unsecured creditors are increasingly aware of preference defenses and how to properly deal with questionable debtors, preference actions are becoming less profitable for the bankruptcy estate. As a result, we’re seeing an increase in the use of fraudulent transfer actions to recover funds for the estate.

There are two types of fraudulent transfer actions: actual fraud (the Debtor deliberately defrauds creditors) an constructive fraud (discussed below). Since actual fraud is somewhat rare, this article is focused on constructively fraudulent transfers.

A transfer is constructively fraudulent if: (1) the debtor received less than reasonably equivalent value in exchange for the transfer and (2) the debtor was (a) insolvent on the date of the transfer or became insolvent as a result of the transfer, (b) the debtor was engaged or was about to engage in a business or transaction for which any property remaining with the debtor was an unreasonably small capital, or (c) the debtor intended to incur or believed that it would incur debts beyond the debtor’s ability to pay as such debts matured.

Most of the cases relating to fraudulent transfers focus on the “reasonably equivalent value” language of the statute. Generally speaking, the courts look to (1) whether the value transferred by the Debtor is approximately equal to the value of what was received by the Debtor in exchange for the transfer and (2) whether the transaction took place at an arm’s length.

In a typical scenario, a vendor provides goods or services having a certain value and the Debtor makes payment sometime thereafter. In this situation, no fraudulent transfer has occurred because the Debtor received “reasonably equivalent value” for its payment.

However, imagine the following scenario: A construction company is composed of three affiliates. Company A cuts timber and delivers it to Company B. Company B processes the timber and makes plywood and delivers it to Company C. Company C uses the plywood to make kitchen cabinets. While these three companies share some common owners, they conduct business at arms-length, do not have any parent-subsidiary relationships and are, for all intents and purposes, separate and distinct legal entities.

Now imagine the creditor that provides $100,000 worth of monthly shipping services for Company A. This creditor is “bankruptcy savvy” and, therefore, insists on 30 day payment terms and strict adherence to payments made in the “ordinary course of business.” All three companies file for chapter 11 bankruptcy protection. When the creditor receives notice of Company A’s bankruptcy, the creditor is secure in knowing that any potential preference action would top out at $300,000 (three months worth of payments) and knows that it has strong defenses to such an action.

Months later, the creditor receives a complaint from the Trustee in Company C’s Bankruptcy demanding the return of $2.4 million worth of “fraudulent transfers.” The complaint indicates that for many years all three companies were insolvent and had problems balancing cash flow. Due to these problems, Company C would pay some of Company A’s Accounts Payable. Pursuant to this arrangement, Company C paid all of the creditors invoices that were directed to Company A. The trustee claims that when Company C paid the monthly invoices for Company A, Company C received no value whatsoever, since the services were delivered to Company A. The trustee therefore demands the return of 2 years worth of monthly payments paid by Company C. Upon review of its file, the creditor is shocked to notice that the checks it received on its invoices were from Company C and not Company A.

Sounds ridiculous, right? Well, while there are certain fact intensive exceptions, such transactions are generally considered “fraudulent transfers” that are recoverable by a bankruptcy trustee.

A creditor that unknowingly receives such a fraudulent transfer is in a very unfortunate situation. While preferences only occur during the 90 days preceding the preference action, the bankruptcy code’s “look back” period for fraudulent transfers is 2 years (which can actually increase depending on which state’s laws apply). Consequently, creditors are at risk of much larger lawsuits being filed to recover fraudulent transfers than the typical preference actions, making it very hard to limit a creditors’ exposure.

More importantly, preference defenses – i.e. ordinary course of business, new value, contemporaneous exchange – do not apply to fraudulent transfers. The fraudulent transfer defenses – typically that the payor received reasonably equivalent value and/or that the payor was insolvent at the time it made the payment – are heavily fact intensive. In other words, the litigation is time consuming and expensive.

For legal and tax purposes, most large companies are split into multiple affiliates, meaning the risks posted by fraudulent transfer actions to unknowing creditors are quite large. For those “bankruptcy savvy” creditors that I mentioned, the best way to protect against such an action is to demand payment from the debtor to which you supplied services. While accepting payment from an affiliate is often the easiest way to get paid timely, it may ultimately end up costing you substantially down the road.

by Shawn P. McClure

Once a claim goes legal, there are many factors that come into play and directly impact a creditor’s ability to get paid.  As a credit professional, you must be aware of these factors to determine their impact on settlement negotiations and how far you decide to push the debtor.  As a creditors’ rights attorney, we must be available to quickly identify how these factors impact litigation and provide our clients with intelligent insight as to how litigation is likely to play out in light of these factors.

The rules of evidence are such a factor.  All of a sudden the forwarded email from a cousin’s mother’s friend who used to work for the debtor may not make it to the trier-of-fact, let alone have the impact the creditor thought it would.   

In the typical creditor-debtor dispute, evidence usually translates to written documents (contracts, invoices, statements, correspondence etc.) setting forth the basis for the parties’ relationship.  As a result of being a simple man, I like to keep in mind three simple concepts when determining whether I can get documents into evidence.  Those concepts are:

1.       Relevance – Why does this matter?

2.       Authentication – Is this real?

3.       Hearsay – Is this reliable?

The first concept is pretty self explanatory and is often easily understood because it involves logic that makes sense to a layperson.  For example, my client’s contract with the debtor is relevant to the issue of whether or not money is owed to my client.  Whereas, my client’s lease with their landlord has no bearing on the issue. 

It is with issues of authentication and hearsay, that clients and attorneys spend an inordinate amount of time explaining to each other and arguing with debtor’s counsel.  I could write pages upon pages trying to explain these concepts, so I will leave you with three helpful tips.  The last being the most useful.  Pay attention to rules on self-authenticating documents to hopefully ease the burden on yourself.  Hearsay is an out of court statement offered for its truth, it remains hearsay even if the declarant is now on the stand during trial.  Lastly, evidence law is determined by the trial judge that you are currently practicing before.  

I would like to wrap up by sharing a recent experience that illustrates why it is important to keep evidence concepts in mind throughout the legal process. 

I recently had a case where debtor’s counsel filed preliminary objections in response to my client’s complaint.  Simultaneously, debtor’s counsel served discovery requests.  More specifically, debtor’s counsel served a request for production of documents seeking the original credit application that was alleged in the complaint.  Debtor’s counsel filed preliminary objections asking the court to dismiss the complaint because we failed to attach the original credit application to our complaint.  The basis for these objections being that the failure to attach the original credit application was a violation of the Best Evidence Doctrine.  Well, we didn’t have the original credit application.  We told debtor’s counsel we didn’t have it in our responses to discovery.  However, in deciding the preliminary objections, the judge correctly overruled the debtor.  As simple as it sounds, debtor’s counsel forgot one importance aspect of the Best Evidence Doctrine.  It doesn’t come into play until a party is trying to put evidence into the record at trial.   

As for how that case turned out at trial … it will probably settle soon.     

by Scott Schuster, Esq.

It is now common to see individuals file 2, 3, even 4 personal bankruptcies. As the economy continues to stagnate, we are beginning to see multiple filers more often. Creditors should be on alert.

One of the primary reasons for the US bankruptcy system is to give debtors a “fresh start.” The theory is that a debtor weighed down by mountains of debt will have no rational motivation to work hard and contribute to society because any accumulated wealth will just be taken by his/her creditors. A bankruptcy discharge allows such a debtor the ability to avoid those debts and get on with his/her life. If such a discharge were not available, thousands of American citizens would have no reason to contribute to society and, therefore, become a burden to the rest of the country.

However, an individual debtor may file bankruptcy and receive a discharge of all of his/her debts once every seven years. In addition to being able to “burn” their creditors more than once, multiple filers pose even greater threats. Most first-time filers are unaware of how bankruptcy works (i.e. what can and cannot be discharged, how long the process takes, etc.). On the other hand, multiple filers know what debts can be readily discharged and are better able to “game” the system.

As a result, second (or third, or fourth . . .) time filers often prepare for bankruptcy years in advance by rebuilding their credit, obtaining credit and increasing their debts gradually, with no real intention to repay those debts. This is fraud, plain and simple. As a result, creditors should be on alert for second-time filers.

If you believe that one of your debtors has committee fraud, you should contact a bankruptcy attorney about the “nondischargeability” provisions in the bankruptcy code that may be available to you. 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. 

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.