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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.

Favorite Child      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.