Demystifying the Ch. 11 Process: What Every Business Debtor Needs to Produce Right After a Filing

Written by Amy Weston, Paralegal and Salene Mazur Kraemer, Esquire

        Fear of the unknown.  The Ch. 11 process is unknown to many.  C-level executives dread  discussions about bankruptcy options.  We just recently filed a new Chapter 11 case and thought we would write a series of posts on basic Ch. 11 procedural matters so as to demystify the process.

      Filing Chapter 11 (reorganization/restructuring) is a powerful tool that can be invoked by businesses and certain individuals pursuant to Title 11  of the United States Code (aka the “Bankruptcy Code”).   As a practitioner,  I am privileged to be able to  facilitate such restructurings.  Here is the first post in this series on Ch. 11 basics.

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           The administrative burden of filing a case can be heavy.  Often, a paralegal is running the “paper pushing” ship just before and shortly after a case is filed.   Information gathering.  Data compilation.  Report generation.  A debtor’s bookkeeper, accountant and/or CFO all work with Debtor’s counsel and paralegal staff to gather  necessary documentation and to fulfill requirements imposed by the Court and the United States Trustee (appointed by Department of Justice).  Each office has very specific document requests, rules and procedures.

          In furtherance of a U.S. Trustee’s monitoring responsibilities, here is a list of what the U.S. Trustee wants prior to the Initial Debtor Interview.  Most of the documentation requested is straightforward and anticipated:

• Bank account statements.
• Latest filed Federal Tax Returns or copy of extension to file.
• Financial statements.
• Payroll detail.
• Rent roll.
• Accounts receivable detail.
• Recently filed sales tax
• Recently filed payroll returns.
• Detail of intercompany transactions.
• Accounts payable detail.
• Check register for last 60 days.
• Filed Scheduled and Petition

Other requirements are not as obvious. Two that specifically need explanation are:

• Proof of establishment of Debtor-In-Possession account(s)
• Proof of insurance indicating that the Office of the U.S. Trustee is an additional certificate holder.

DIP Accounts

         Once a debtor has filed a bankruptcy petition, it must close existing bank accounts and open new accounts which identify the debtor as a debtor in possession (“DIP”). All money from the bankruptcy “estate” (i.e. anything the debtor owns) must be put into these accounts.  The title of “Debtor in Possession” must be printed on the checks along with the bankruptcy case number.  The Bank will not issue a debit card for a DIP account.

        While this seems complicated at first, the good news is that this is standard procedure. So, any bank should be familiar with this request.  However, a debtor cannot go to just “any” bank. The U.S. Trustee’s Office will only accept DIP accounts from approved depositories.  A current list of such institutions is available through the U. S. Bankruptcy Court in the district where the bankruptcy was filed.  Approved Banks DIP

              Within 15 days of receipt from the bank, a debtor must serve copies of monthly bank statements upon all creditors and interested parties, together with a monthly operating report (MOR) of gross receipts and disbursements.  Both the monthly operating report (MOR) and DIP bank statements are publicly filed on a debtor’s docket.

Proof of Insurance

          A debtor must maintain all insurance coverage during the bankruptcy process.   This includes: general comprehensive liability; property loss from fire, theft or water; vehicle; workers’ compensation; and any other coverage that would be customary in line with the debtor’s business.

           In addition to maintenance, a debtor must list the Office of the U.S. Trustee listed as an additional certificate holder and provide proof of such.  The documentation of proof must include the type and extent of coverage, effective dates, and insurance carrier information.  In order to fulfill the Trustee’s requirements, the debtor will usually have to provide proof of the request.   The proof of insurance and additional certificate holder requirement is standard, so the insurance company should not have any trouble fulfilling a debtor’s request.

          Please TAKE NOTE that a debtor’s failure to comply could result in DISMISSAL of the case or conversion to a Chapter 7.

If the case is a designated as a small business case or as a subchapter V small business case, there are additional  requirements.

This post does not constitute legal advice.  Consult an attorney about your specific case.

Avoiding Emergency Bankruptcy Filings

It was the day before Thanksgiving.  A friend of mine called me in a panic.   She received a notification that her bank account was frozen by a creditor; she was to get a direct deposit of her salary in the next 2 days, which was two weeks before Christmas.  She needed to file bankruptcy fast in order to trigger the automatic stay (legal principle that means no creditor can take action to harm you).

I stayed up until midnight that day in order to get the case filed for her.  Her business had gone bad and this was the fallout from it.

Often, bankruptcy cases are filed on an emergency basis. In many instances, time may be of the essence and you need to file the case immediately (e.g. a creditor  has a judgment against you and has sent the Sheriff to your home or business; you have received a notice of garnishment of your wages or bank account by a taxing body).  If this firedrill can be avoided, it should be.

Rushing into a case is pretty much never a good idea.   Filing the petition on an emergency basis only increases the costs of your case and there may not be enough time to research potential issues that may arise during the course of your case.   You may omit important creditors.  You may omit assets.  If the schedules are not accurate,  you will need to amend them and that costs more money to do.  Substantial, repeated amendments do not leave favorable impressions upon the U.S. Trustee or the Ch. 7 Trustee.

A debtor is permitted to file a barebones “emergency “bankruptcy petition together with a list of 20 largest creditors. The full set of schedules must be submitted within 14 days, unless extended.

Regardless of whether the case is an emergency filing or not, if you are an individual, you MUST complete pre-bankruptcy filing credit counseling course at least 24 hours before any case is filed.

BOTTOM LINE:

• Talk to an attorney.  He or she can give you the questionnaire you need to fill out well ahead of time. He or she will also give you a list of documents you will need You can start gathering that info.  If the case is billed hourly, you will save yourself money by gathering up this information rather than having a paralegal do it.
• Pre-bankruptcy planning is always advisable for any individual or business.  You don’t want to throw good money after bad (meaning you don’t want to pay down debt that ultimately may be discharged). You don’t want to make preferential or fraudulent transfers.    Often, there are non-bankruptcy options, particularly for businesses (but that can be a topic for another blog post).

DISCLAIMER:  This does  not constitute legal advice.  This post does not create an attorney client relationship.  Consultant an attorney for more information re: this topic.

“Dance Moms” Instructor Abby Lee Miller Files for Chapter 11 Protection: Public Disclosure of Private Facts

By: Justin A. Saporito, MAZURKRAEMER Law Clerk and Salene Mazur Kraemer

Salene’s Preface: I was in Bankruptcy Court last week in Pittsburgh and noticed Abby walking into Court.  (She is a stunning woman by the way and you can understand why she is on TV).  I had to ask myself, “How do I know her?”  I did figure it out pretty quickly.   I was surprised to see her on my turf (that is in the world of commercial bankruptcy) and was not aware that Abby had filed for Ch. 11.  My daughter is a dancer and I watch the show! 

Abigale Lee Miller filed for Chapter 11 relief on January 3rd, 2011.  The petition was filed in the United States Bankruptcy Court for the Western District of Pennsylvania under petition number: 10-28606 TPA and has been overseen by the Honorable Judge Thomas P. Agresti.

Debtor is better known as Abby Lee Miller, the host and instructor for the popular Lifetime reality television show Dance Moms.  The show follows a group mothers and their young daughters who are participating in the world of young competitive dance.  The show takes place in Pittsburgh, PA at the debtor’s studio, the Abby Lee Dance Company, and follows the ladies as they travel across the country to various competitions.  Dance Moms is currently holding open casting calls for its 4^th season.

The Abby Lee Dance Company was formed 27 years ago as a not-for-profit organization and is an audition only program.  It is located at 7123 Saltsburg Road, Pittsburgh, PA, 15235.  Debtor is also the owner of Reign Dance Productions, which shares the building with The Abby Lee Dance Company.

Debtor has declared approximately $325,500 in assets with approximately $356,500 in liabilities.   Thirty-four creditors are listed in the petition, with Chase Mortgage holding the largest unsecured claim in the amount of $50,000.   This debt is the unsecured portion of what appears to be a $200,000 undersecured mortgage on a home of Ms. Miller’s in Florida valued at $150k.   Ms. Miller’s dance studio has a $96,000 mortgage on it; the studio is valued at around $150,000  Ms. Miller owes about $27,000 in back taxes (which are unsecured priority claims).  Her unsecured debt only totals $32,000, many of whom are vendors for her business.

The Second Amended Disclosure Statement was approved on January 18^th, 2013 and the Order Approving Disclosure Statement and Scheduling Hearing on Plan Confirmation was entered into on October 21^st, 2013.  Please click here to for a copy of the order.  The debtor is represented by Donald R. Calaiaro of Calaiaro & Corbett, P.C.  The Confirmation Hearing to approve her Plan of Reorganization is set for December 12, 2013 at 1:30 p.m. EST.  Please click here for a copy of the Disclosure Statement.  A summary of the Chapter 11 plan can be found here.

Salene’s comment:   We purposefully do not often write blog posts about individual Chapter 11 cases (usually filed by very wealth individuals.  Most folks file a Chapter 7 or Chapter 13).  When a company or person files for bankruptcy,  I warn my clients that you are subjecting yourselves to a “financial autopsy”; you are making a public filing of all of your assets and liabilities.  So, information seekers can look up what your home is worth, what kind of car you drive,  how much credit card debt you have, whether you own a fur coat, how much your wedding ring costs, and whether you have any money in an IRA/401k.  Anyone can see how much money you have made in the last three years and they get to read what your monthly budget is for expenses.   While there are certainly benefits to the privilege of filing for bankruptcy, public disclosure of private facts is certainly one of the drawbacks.

Inside the Trenches of a Chapter 11: The Firehose of the First 30 Days

    The first 30 days of a Chapter 11 bankruptcy case often are like water spewing violently out of a fire hydrant.  Fast.   Furious.  Urgent.  Many issues being thrown at the Debtor, its employees, and its lawyers at one time.

According to the Pre-Bankruptcy Planning for the Commercial Reorganization: A Brief Guide for the CEO, CFO/COO, General Counsel and Tax Advisor, written by the Reorganization and Restructuring Group of Squire, Sanders & Dempsey, LLP (2nd edition, 2008), a whopping 83 percent of chapter 11 reorganizations that are filed generally “die on the vine” and are never confirmed.

I purchased this Brief Guide at the American Bankruptcy Institute that I attended this past Spring and I thought I would write a few blog posts integrating my experience with the concise content of the book.  As set forth on Appendix A to the Guide, generally certain matters must be addressed within the first 30 days of a case.

• Petition filed

• Filing of list of 20 largest creditors

• Applications for retention of professionals (attorneys, accountants, turnaround professionals, valuation specialists, real estate brokers).  A Debtor cannot pay a professional unless the retention of the firm is first approved by the Judge and the professional files a fee application on the docket, to which parties may review and/or object.

• Filing of ”first day” motions (seeking authority to pay wages, use pre-petition bank accounts, pay deposits for utilities, use of cash collateral, payment of interim compensation to professionals)

• Filing of schedules of assets and liabilities and statement of financial affairs.  Getting correct addresses and dollar amounts owed for every single creditor often is a daunting task.  Once the Schedules are filed, a creditor matrix is generated. The Bankruptcy Court and parties in interest use this address list to mail or “serve” important pleadings in the case. If the matrix is enormous, certain limited servicing lists can be authorized by the Court. In mega-cases, servicing agents are employed by the Debtor to handle only this aspect of the case, i.e., proper service.

• Filing of Corporate Resolution authorizing the Chapter 11 filing

• Negotiation of debtor in possession financing

• Hearing on use of cash collateral and adequate protection

• Negotiation with trade creditors regarding reclamation claims and/or reestablishment of trade terms.

The first few weeks of a case can be exhausting and dramatic.  Often, by the time a petition is filed, a debtor runs out of money and payroll has not been paid (therefore employees are angry and morale is low), bank accounts frozen, the utilities have been shut off, and/or the front doors have been padlocked by a creditor.   Once a case is filed, a creditor may immediately file a motion to dismiss the case.

The filing of the petition and related schedules requires a financial autopsy of a business and all of its related entities. In order to avoid confusion down the road, Debtor’s counsel should try to obtain as much factually accurate information as possible during this time. The process requires persistence, diligence and coordination with the Debtor’s employees, who basically become your co-workers for as long as the case is open, which could be 18 months or longer.

During this critical time, management and key employees must be counseled regarding what to do and not do, now that the actions of the Debtor are under close scrutiny by not only a Judge but also a U.S. Trustee as well as the creditor body. Employees should be clear regarding what transfers may or may not be made without court approval.  Also, at the same time, the U.S. Trustee’s Office dictates that a debtor comply with its financial reporting requirements (hence the required “Monthly Operating Report”), and the filing of insurance and bank account information.  Lack of compliance may lead to a dismissal of the case or a conversion to a Chapter 7.  Often the debtor must close pre-petition bank accounts and open new ones.

Keeping all constituencies informed is an important part of the role of Debtor’s counsel.  Creditors may include key lenders and critical vendors who will want to know what the turnaround strategy is for the company. Once creditors receive the “Notice of Suggestion of Bankruptcy”, they too will be scurrying around to hire bankruptcy lawyers if the size of their claims warrants such an expense.

“FORE!” – Beulah Road Land Company Files for Chapter 11

BY: Katie Imler

On July 26, 2013 Beulah Road Land Company filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the Western District of Pennsylvania (Case No. 2:13-bk-23148).  The Debtor, located at 800 Beulah Road, Pittsburgh, Pa 15235, is the new majority owner of the land on which the Churchill Valley Country Club sits.  The Debtor has been fighting with creditors of the club, as to who owns the 147-acre property.   These creditors forced Churchill Valley Country Club into a Chapter 7 bankruptcy (Case No. 13-23122 filed July 25, 2013).  At the same time, Zokaites Properties, Inc. recently purchased the outstanding $1.2 million mortgage held on the club and property from PNC Bank.  A local lawyer and ex-business partner of Zokaites is challenging this transfer.

The Beulah bankruptcy case has been assigned to the Honorable Judge Carlota M. Bohm. In the petition signed by the Debtor’s President Richard Hersberger, the Debtor listed $1-$10 million in assets and $1-$10 million in liabilities.  All Schedules are due August 9, 2013.  The Chapter 11 Plan and Disclosure Statement are due November 25, 2013.  On August 1, 2013, creditor Zokaites Properties, Inc. by and through its attorney Jeffrey Hulton, made a motion to dismiss the bankruptcy case.  There will be a hearing regarding the motion to dismiss on August 9, 2013 at 3:00pm.

The largest creditors include several law firms, the Penn Hills School District, PNC Bank, and the Woodland Hill School District.

The Debtor is represented by Donald R. Calaiaro of Calaiaro & Corbett, P.C. located at 310 Grant Street, Suite 1105, Pittsburgh, PA 15219. The US Trustee is represented by Norma Hildenbrand located at Suite 970 Liberty Center, 1001 Liberty Ave., Pittsburgh, PA 15222.

Bankruptcy Docket Beat: Ashland, KY’s River Cities Glass & Construction Files for Chapter 11 in WV

On May 2, 2013, River Cities Glass & Construction, LLC, a glass and glazing contractors company, located at 4750 Winchester Avenue, Ashland, KY 41101 filed a voluntary Chapter 11 bankruptcy protection in the Southern District of West Virginia (Huntington), assigned case No. 3:13-bk-30226 (RGP).  The case was assigned to the Honorable Judge Ronald G. Pearson.  See docket here.  William Cox signed the Debtor’s Schedules as President of the Debtor.

The Debtor is represented by Mitchell Lee Klein of the Klein Law Office, 3566 Teays Valley Road, Hurricane, WV 25526.  Klein’s disclosed a retainer of $5,000 and an hourly rate of $200/hour.

            The Debtor elected to be considered a “small business debtor” pursuant to Bankruptcy Code Section 1116.   Its Chapter 11 Plan is due in 6 months, or by October 29, 2013.  Its Disclosure Statement is also due on October 29, 2013.   The Debtor listed liabilities of $159,936.01 and assets under $50,000 with less than 50 creditors.  Simultaneously with its voluntary petition, the Debtor filed an initial operating report and an application to employ an attorney.  Because this is a “small debtor case”, in addition to filing a petition, schedules and a statement of financial affairs, the Debtor is required to also submit a balance sheet, statement of operation, and a cash flow statement, as well as a federal tax return.

New Bankruptcy Code Section 1116  imposes duties on a small business debtor beyond not required of other Chapter 11 debtors, beginning with the filing of the petition.  Under § 1116(1), the debtor must attach to its petition (or in an involuntary case, file within seven days after the date of the order for relief) either (a) its most recent balance sheet, statement of operations, cash flow statement and federal income tax return or (b) a statement made under oath that such documents have not been prepared and that such tax return has not been filed.

We found this listing on the salespider website for the Debtor; we are not certain when it was ever initially listed.  The listing stated that the company has about 7 employees and estimated yearly revenue of $1,200,000 and that the Debtor’s SIC Code is 5231.  This industry consists of establishments engaged in selling primarily paint, glass, and wallpaper, or any combination of these lines, to the general public.  While these establishments may sell primarily to construction contractors, they are known as retail in the trade.  Establishments that do not sell to the general public or are known in the trade as wholesale are classified in the wholesale trade industries.   See SIC Code article here.

Bankruptcy Docket Beat: Philadelphia’s Mike’s Open Face Breakfast Files for Chapter 11

On April 23, 2013, Debtor Mike’s Open Face Breakfast, Inc. of 107 W. Chelten Avenue, Philadelphia, PA 19144 filed a Chapter 11 bankruptcy petition in the Bankruptcy Court for the Eastern District of Pennsylvania (Philadelphia), Case No. 13-13583-elf.  Debtor’s counsel is Hae Yeon Baik, of Baik & Associates, PC, 2333 Fairmount Avenue,1^st Floor Left, Philadelphia, PA 19130.  The case has been assigned to Honorable Chief Judge Eric L. Frank.  The Debtor’s assets are  less than $50,000 and the liabilities are less than $50,000.   The Debtor has yet to file a full set of schedules and a statement of financial affairs.  The Debtor will have 15 days from the Petition Date in which to do so, unless the Debtor’s counsel seeks and extension of such a deadline.

A summary of the docket for this Chapter 11 can be viewed here.

Mike’s Open Face Breakfast operates as a breakfast and lunch spot in the Germantown area of Philadelphia, just outside of one of my old stomping grounds Chestnut Hill, Pennsylvania (got my first post-law school apartment there).

Notably, Mike’s Open Face Breakfast filed as a “small business debtor case” filed by a “small business debtor”.  Pursuant to Bankruptcy Code 101, in order to be a “small business debtor”, a debtor must have aggregate noncontingent liquidated, secured and unsecured debts as of the date of the petition in an amount not more than $2,190,000 (excluding debts owed to 1 or more affiliates or insiders). 11 U.S.C. ss 101(51D).  The debtor must be engaged in commercial or business activities (other than primarily owning or operating real property).  Also, the case must be one in which a U.S. trustee has not appointed a creditors’ committee, or the court has determined that the creditors’ committee is insufficiently active and representative to provide oversight of the debtor.  11 U.S.C. ss 101(51D).

What is the impact of the “small business debtor case” designation?  The most obvious benefit is that typically the case proceeds more quickly, but at that same time the debtor is subjected to more U.S. trustee oversight and is required to comply with more procedural filing requirements.  For a great article re: “small business debtor cases”,  click here.

Ch. 7 or Ch. 11: Which Bankruptcy Option Is Best For My Business?

CO-AUTHORS: Katie Imler and Salene Kraemer

Let’s face it, all businesses face challenges. Especially when the economy is not a booming bull, financial challenges are in abundance. You are not alone. So what do you do when your company has financial troubles staring you down? What do you do when going to work every day puts you and your family deeper in debt instead of adding money to your bank account? At some point, the best business decision you can make may be the decision to no longer do business.

What do you do?  Well, there are a few options:  1) Sell the business to a competitor, strategic business, or key employee; 2) File for Chapter 7 bankruptcy; 3) Wind-down the company yourself. We want to talk about the latter two options. Before taking action, both avenues have advantages and disadvantages that must be weighed.

Avenue 7. Filing for Chapter 7 Bankruptcy means that a Bankruptcy Trustee employed by Office of the United States Trustee of the Department of Justice, steps into the shoes of the company and has the burden of winding-down the business.  In doing so, the Trustee is in control of distributing the business assets according to the Bankruptcy Code.

Perks of Chapter 7:

• Upon filing a petition for Chapter 7, an automatic stay is imposed preventing lawsuits and writs of execution against business assets –think of it as MC Hammer’s “Can’t Touch This.” This preserves the vital business assets and provides peace of mind that the business will not have to defend against future legal actions arising from pre-petition debts
• The Bankruptcy Court assumes the burden of notifying all creditors of the bankruptcy (sending the “funeral notice”, if you will).  Having this objective third party serve as a buffer between the business owner and the unpaid creditor provides a sense of relief to the business owner
• Debtor benefits from expertise of an experienced Bankruptcy Trustee
• Debt forgiveness is not taxable

Downsides of Chapter 7:

• Business management has no control in the winding-down
• Trustee will scrutinize the pre-petition financial and operational affairs of the Debtor
• Instead of finding a strategic buyer who may pay more for business assets, a trustee may liquidate business assets for pennies on the dollar, called a “fire sale”
• Trustee may abandon certain assets letting creditors with an interest in them duke it out
• Since the Trustee assumes the place of the debtor, he or she also assumes all of the debtor’s legal claims. The debtor, therefore, may be without standing to pursue a future lawsuit arising out of pre-petition transactions, unless otherwise agreed
• Furthermore, filing for bankruptcy creates a public record and may pick up media attention, depending upon your business
• Time and monetary costs are also associated with Chapter 7.  In addition to attorney’s fees, the filing fee alone is $306 and the Debtor will have to pay Trustee’s fees if there are assets for the Trustee to liquidate. Plus, the Trustee’s fees come off the top of liquidation proceeds before any distributions to creditors are made.

The Wind-Down Alternative.  If you are a do-it-yourself personality, then the Wind-down approach may be the approach for you. In this scenario, you control the winding-down process of the company and pay off the debts. However, this do-it-yourself project may require a thick skin and much cooperation from your creditors and lessors.

Perks of Non-Bankruptcy Wind-down:

• Winding-Down the business yourself avoids the legal and bankruptcy fees
• Business owner retains control and does not expose dirty laundry to the public
• Business avoids scrutiny by the Trustee
• Higher likelihood that you, the business owner with the industry know-how, will find a better buyer in the market who is willing to pay more for business assets

Downsides of Non-Bankruptcy Wind-down:

• Creditors may initiate an involuntary Chapter 7 bankruptcy petition against your business
• Business must comply with state laws for dissolving which are usually more demanding than the Bankruptcy Code and take longer to execute. If liquidation is done incorrectly, the business can be exposed to lawsuits for dishonoring creditors’ legal rights
• Business owner personally deals with all of the creditors and is responsible for all issues that arise.
• Debt forgiveness is taxable outside of bankruptcy

Now, do you file for Chapter 7 or Wind-down? In some cases, a hybrid approach may be best. Go as far as feasible in the liquidation process on your own, and then turn it over to a Trustee or a bankruptcy  lawyer to finish the job.  Weigh which option suits your needs the most, reflecting upon your unique business, the nature and amount of the debt that your business still owes, and your personal capabilities.  And, as always, it is best to first consult with your attorney.

MAZURKRAEMER represents debtors and creditors in bankruptcy courts all over the country. The information, comments and links posted on this blog do not constitute legal advice. No attorney-client relationship has been or will be formed by any communication(s) to, from or with the blog and/or the blogger. For legal advice, contact an attorney at MAZURKRAEMER or an attorney actively practicing in your jurisdiction.

Inside the Trenches of a Chapter 11 Bankruptcy Case-Preparing the Initial Filing

       In the world of business law, many seem to be mystified by the chapter 11 bankruptcy process.   When I tell my friends and colleagues what I do, they still don’t seem to understand me.  I get that glazed, deer-in-headlights look.   I just recently filed a Chapter 11 case and I decided to write a series of blog posts as we are going through the process.

        The chapter 11 process is expensive but can be a worthwhile option and a financially prudent decision for certain businesses wishing to reorganize, restructure their debts, reject undesirable contracts, and/or orderly liquidate certain assets under the jurisdiction and protection of the bankruptcy court.

Triggering Event.  Usually an event triggers the filing (a pending auction of assets, an inability to payroll, the threat of a shut-off notice for utilities, a impending freezing of bank accounts, a filed lawsuit, etc.).  A debtor can file an emergency petition in such an instance.

Emergency Petition.  To file an emergency petition, at the very minimum a debtor needs to submit the 2-page petition, its list of 20 largest unsecured creditors, and a creditor matrix (listing all of the creditors the debtor believes it currently has).    This sounds like a simple initial filing; but, it might not be.   The preparation of the debtor’s bankruptcy petition and related schedules can be very time-consuming depending upon the nature of the debtor’s business, how orderly its books and records are, and how many divisions or locations, it has etc.

Automatic Stay.  Once the minimal skeletal documents are filed, an “automatic stay” goes into immediate effect; the automatic stay is basically an injunction against any and all actions against the debtor and is property.    If a creditor violates the stay, it is a serious infringement and the bankruptcy court can award sanctions  against the creditor.

After the initial bankruptcy petition is filed, a Ch. 11 debtor has another 14 days within which to file its complete schedules and statement of financial affairs.   This timeframe can be extended for cause.

“Debtor In Possession” Bank and Insurance Information.  Also once the petition is filed, generally within 10 days, the debtor and its counsel have to submit certain bank account and insurance information to the United States Trustee (part of the Department of Justice).    Importantly, a business must close its books as of its bankruptcy “Petition Date” and open up  a new set of financial books and records.  New “Debtor-in-Possession” (“DIP”) Bank accounts must be opened at certain approved banks;  the United States Trustee’s Office has the “approved” list of banks.  The debtor and its counsel also may have an initial debtor interview with the agent for the United States Trustee (depending  upon the district in which you file), at which the debtor discusses its business operations and assets and liabilities.

The Bankruptcy Court Is Watching.  Once a bankruptcy petition is filed, a business will then have to seek bankruptcy court approval prior to taking many actions (paying its lawyers and accountants, paying pre-petition wages, utilizing cash (“cash collateral”) to pay expenses, selling anything outside the ordinary course).   A business debtor post-petition generally CANNOT pay any pre-petition obligations, otherwise serious consequences may ensure, including “avoidance” lawsuits. 

Drama.  The initial filing process can be intense for everyone involved.  Lots of information gathering, document review, fact checking.   Many phone calls may be made to and from creditors about the impact of the filing of the case.

Often, a distressed situation, not surprisingly, involves drama.  In some instances I have had to file the case right before the auction on the courthouse steps, right before the repossession crew found the vehicle, or right after the doors to a business were locked and the business suddenly went dark.  After the petition is filed and is made known to the public, media outlets may starting calling to find out more about the future of the business.

STAY TUNED FOR MORE DETAILS REGARDING INSIDE THE TRENCHES OF A CHAPTER 11 BANKRUPTCY CASE

MAZURKRAEMER represents debtors and creditors in bankruptcy courts all over the country.   The information, comments and links posted on this blog do not constitute legal advice. No attorney-client relationship has been or will be formed by any communication(s) to, from or with the blog and/or the blogger. For legal advice, contact an attorney at MAZURKRAEMER or an attorney actively practicing in your jurisdiction.

What the Heck Is a Preference Action: Paying Off Favorite Creditors as a Business Tanks

       Preferential Treatment.  My two older siblings Nathan and Nicole and I often teased my folks about being the favorite kid, each of us jockeying for the favorite position (not really).  I will be writing a series of posts on paying a favorite creditor and the consequences of a debtor doing so as his or her business slides into bankruptcy.  This is the first post.  (I have a 50 page research treatise that I wrote, from which I am pulling to create these posts!).  I will try to make the subject matter as interesting as possible.

      I have been prosecuting and defending the recovery of alleged preferential transfers since my first few weeks as a bankruptcy associate at a large firm in Philadelphia and Wilmington, DE.   I have developed a massive library of research regarding this special type of litigation that arises only  in a bankruptcy case.   So let’s start with the basics; what is a preference action?

As business owners and management see the tell-tale signs that they are going to close their doors or reorganize, the issue always comes up—who can I pay now and in what order?  Often, we see significant outstanding tax liability, much of which consists of trust fund taxes (i.e., payroll, sales taxes, etc.) for which the owners of the company are personally liable.  We also see mom and dads or related companies (aka insiders) lend an ailing business sizable chunks of money on an unsecured basis.   We also see business owners who feel terrible stiffing their long-term business buddy suppliers because they know if that last payment is not made, then the suppliers’ business will become troubled too.   In their darkest hour of distress, as the lights are about to go out, the owners scurry to pay “preferred” creditors.

But, the Bankruptcy Code provides a recourse to protect those creditors who are not on the preferred list.   Specifically, pursuant to 11 U.S.C.§ 547 (aka Bankruptcy Code §547(b)), a preference action is a statutory right unique to bankruptcy that allows a debtor-in-possession or trustee to recover transfers made to a creditor within 90 days of a bankruptcy filing or within 1 year if to an insider, where such transfers were made to pay pre-existing debt.   By initiating preference lawsuits inside of a bankruptcy proceeding, a bankruptcy trust or debtor is able to sue the creditors that it once “preferred” (either voluntarily or involuntarily) in order to claw back those monies into a debtor’s estate for fair distribution to all unsecured creditors.

The five basic elements of a preference are as follows:

• The transfer must be made (1) to or for the benefit of a creditor,
• (2) on account of an antecedent debt,
• (3) while the debtor is insolvent,
• (4) within ninety days before bankruptcy (for non-insiders) or within one year (for insiders); and
• (5) the transfer must enable the creditor to receive a greater amount had the transfer not occurred and had the creditor received payment in a hypothetical Chapter 7 liquidation.

All of these elements of a preference under Section 547(b) of the Bankruptcy Code must be present.  If the plaintiff trustee/debtor-in-possession cannot prove a transfer’s avoidability by a “preponderance of the evidence” (generally the ability to prove as “more likely than not” that the five preference elements exist) then a defendant creditor will prevail.  Note that, neither the debtor nor the creditor’s intent regarding the transfer is a material factor in the consideration of an alleged preference (more on this later).

I have been on both the prosecuting and defending side of numerous preference cases.  When a debtor initiates preference actions, often a debtor is directed to pull its check register to identify payments and persons that the debtor has paid over the last year.  Sometimes, those names, addresses and payments are placed into an excel spreadsheet that is then merged with a form complaint.  The preference lawsuits are then filed in “batches.”   I have seen hundreds of preference actions filed in a batch.   Truth be told then — often, not a whole lot of diligence is put into determining whether a debtor’s actually preferred a certain creditor defendant (i.e., whether the debtor or trustee can satisfy each of the statutory elements of a preferential transfer  and/or whether a defendant will have any valid defenses to the action that will either limit or eliminate liability).    So the lawsuit is set in motion and now each creditor defendant to hire a bankruptcy lawyer and defend the lawsuit by either asserting that the plaintiff has not satisfied each of the prima facie elements set forth in the statute and/or asserting an affirmative defense.

Preference laws were designed to facilitate a fundamental bankruptcy policy of equality of distribution among creditors of the debtor.  Nonetheless, in practice, preference actions are often viewed by creditors as extremely punitive, inasmuch as their effect is to cause creditors to disgorge funds that they have received for legitimate, undisputed bills.   Fortunately, as referred to above, the bankruptcy statute also provides numerous defenses to a preference claim that can often substantially reduce or eliminate liability that would otherwise arise if the defenses are not timely asserted.   I will discuss defenses in another post!  Stay tuned.

MAZURKRAEMER represents debtors and creditors in bankruptcy courts all over the country. The information, comments and links posted on this blog do not constitute legal advice. No attorney-client relationship has been or will be formed by any communication(s) to, from or with the blog and/or the blogger. For legal advice, contact an attorney at MAZURKRAEMER or an attorney actively practicing in your jurisdiction.