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

There is perhaps nothing more frustrating than when one of your customers files bankruptcy and avoids paying money that they owe your company. However, anyone that has dealt with a “preference action” knows that merely writing off a debt as uncollectible is not the worst thing that can happen when a customer enters bankruptcy. A preference action has the potential to be much worse, because it is a lawsuit by the debtor or the bankruptcy trustee against your company, seeking to recover payments that were made by the debtor to your company before the bankruptcy. Fortunately, the Bankruptcy Code provides creditors with certain defenses that can be used to defeat a preference action.

The Bankruptcy Code permits the trustee to avoid and recover from creditors payments made within the 90-day period before the bankruptcy filing. The policy behind this provision is to prevent aggressive collection activities that often force the debtor into bankruptcy. 

A “preference” is defined by Section 547 of the Bankruptcy Code as:

1. Payment on an “antecedent” (meaning a previously incurred as opposed to current) debt;
2. Made while the debtor was insolvent (meaning its assets are less than its liabilities);
3. To a non insider creditor, within 90 days of the filing of the bankruptcy;
4. That allows the creditor to receive more on its claim than it would have, had the payment not been made and the claim paid through the bankruptcy proceeding.  

Section 550 of the Bankruptcy Code allows the trustee to avoid and recover any preference payments by filing a lawsuit against the creditor.

Typically, a preference action is often preceded by a “demand letter” from the debtor or the trustee. The demand letter sets forth the trustee’s claims and demands immediate payment. Often times the trustee is willing to settle the preference action for an extremely reduced amount if the settlement is reached before the lawsuit is filed. Consequently, when the creditor receives a “preference demand letter,” the creditor should always have experienced bankruptcy counsel review the case to determine whether the creditor has valid defenses. Bankruptcy counsel can often negotiate a favorable settlement and allow the creditor to avoid having to expend large sums of money in litigation.

If the parties do not reach a settlement, the preference action is initiated with a complaint filed with the bankruptcy court. The preference complaint is similar to any other lawsuit with the exception that its filed in bankruptcy court, rather than federal district or state court.

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.

by Shawn McClure

As a potential creditor, you have heard this message time and time again.  Do your homework!  Prior to extending credit to a new customer make sure to obtain as much information as possible regarding this new customer’s credit history.  As a creditors’ rights attorney, I urge you to include within this initial investigation the task of finding out a little about the customer’s present operations.  More specifically, find out where this new customer currently banks. 

Customer banking information is extremely valuable in the event that the relationship sours down the road, and you are forced to take legal action to collect on an outstanding account.  Moreover, in the early stages of the creditor/debtor relationship obtaining such information should be effortless.  A new customer who refuses to provide a banking reference should at the very least raise a red flag.     

In my experience, a bank attachment is typically the fastest and most successful form of execution upon a judgment.  It gets the creditor what they want (cash), and it does so in a relatively quick manner (the bank will have twenty days from the date of service to inform a creditor of any funds that may be available).  Of course there are procedural steps that your attorney will need to take in order to receive payment, but those steps can be taken quickly.   

So if in your current practice you are not already asking new customers for banking information, begin doing so.  For existing customers, I would suggest taking the time to note where current payments are coming from.  By expending minimal effort now, you have taken steps that can drastically improve your chances of recovery in the event that the account defaults.

by Jack P. Bock

by Scott Schuster

Small cases, that often do not seem to be worth pursuing at all, can have a big impact on your company’s bottom line. I have often heard clients say “I want to pursue this as a matter of principle, but I’m not sure it’s worth the cost.” Some attorneys agree. However, pursuing and winning such a case tells the world that you are serious about collecting your debts and that message is often far more valuable than expected.

I recently defended a case wherein the debtor attempted to discharge certain student loans through bankruptcy. The amount of the debt was small ($20,000) and the monthly payment ($122 per month for 25 years) was insufficient to make any noticeable impact on the client’s monthly financials.

However, the debtor’s case was absolutely frivolous because the Bankruptcy Code makes discharge of student loans subject to very stringent conditions. The Code states that student loans are not discharged unless the debtor can show that it would be an “undue hardship” to force the debtor repay the debt. Typically, to prove an undue hardship, a debtor must provide evidence that the debtor has minimized his or her expenses and maximized his or her income.

The aforementioned case was frivolous because the debtor, who was disabled and only earned $1,300 per month from social security disability, lived in a $285,000, five bedroom, three bathroom home that was paid for by her husband. Debtor’s SSI income was used to support the $1,800 in mortgage payments the family made each month. More egregiously, the Debtor was disabled when she accepted the student loan and agreed to repay the money.

Despite the fact that paying $122 per month would not cause an “undue hardship,” Debtor filed a complaint seeking to discharge the student loan. The client immediately asked whether the case was “worth pursuing.” Clearly, the client would win the case if we fought hard enough, but the debt was small.

My advice to the client was to take a step back and look at the case in the grander scheme of its business operations. The Debtor’s attorney in the case has practiced for many years and files dozens of bankruptcies each year. If the client were to “roll over” and show that it would not fight the smaller cases, the attorney would know what he could get away with in future cases. One thing I pointed out to the client is that debtors’ attorneys tend to be very friendly with one another and tend to share their experiences. As a result, showing weakness in this case could give rise to dozens of frivolous student loan dischargeability actions in the future.

In the end, we litigated the matter. The parties exchanged discovery, conducted depositions, and eventually filed motions with the court seeking summary judgment. Debtor’s counsel was flabbergasted; he repeatedly said ”I cannot believe your client is fighting this case.” In the end, he probably spent ten times more time and effort on the case than he expected. I flew to Philadelphia to argue the case and put our argument - that Debtor’s lavish lifestyle is not an “undue hardship” - on the record. The Judge agreed and entered an order in our favor, excepting the debt from discharge and guaranteeing that the debtor could not take the easy way out.

Yes, the client spent some money to litigate the case and the immediate result ($122 per month for the next 25 years or so) will make no difference to the client’s year-end profit. However, the client took a stand and made it known that, as a matter of principle, frivolous cases will be defended. Debtor’s attorneys will think twice about filing such a claim the next time around.

Many bankruptcy attorneys are concerned about the efficiency of their process. By definition, at least the debtor has limited funds to pay for an engagement. This impacts the creditors who may not see a full recovery on their claim. As a result, many bankruptcy practitioners are leery of spending any resources on electronic discovery. This podcast was created to share the experiences of Bob Bernstein, a bankrupcty practitioner in Pittsburgh, PA with Bernstein Law Firm and Jeffrey Ritter, an electronic discovery consultant from the Waters Edge who has just written a book on electronic discovery and the bankruptcy process called Discovering the Digital Record-The Questions for Examination. 

Click link to listen to Podcast: http://www.esibytes.com/?p=718