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The Company You Own Files Bankruptcy: Can Creditors Still Come After You?

automatic-stayAs is almost always the case, principals of a distressed business have personally guaranteed the debt on a credit line or property or equipment lease. When a business files bankruptcy, an automatic stay is imposed against any adverse actions taken against the business entity, the Debtor. But what about the owners of the business? Often, I find myself seeking to extend the automatic stay injunction to those principals. This issue came up in a recent case we had pending in the Fourth Circuit. We were compelled to find case law regarding the standard for relief.

A factual example would be as follows: A distressed business ABC Recylcing owns a building, and the building has a mortgage on it in favor of Meanie Bank, N.A.  The business falls behind on payments. Meanie Bank initiates a foreclosure action to set an auction to sell the building. Jake, the owner of the business had to sign a guaranty in order for ABC Recycling to get the loan with Meanie Bank. ABC Recycling still operates with the faint hopes of reorganizing through a Chapter 11 bankruptcy. Once the Chapter 11 is filed, the foreclosure action is stayed as to ABC Recycling, but now the Meanie Bank is going after Jake. Help, my clients say.

ISSUE: Pursuant 11 U.S.C. §105 and §362 of the Bankruptcy Code, is a court likely to grant an injunction to protect the principal of a bankrupt business?

CONCLUSION: Where the principal Jack is a primary guarantor of the mortgage and Meanie Bank now intends to secure a judgment against the principal, the principal will only be able to obtain an injunction by demonstrating a mutuality of identity with the Debtor such that allowing Meanie Bank to proceed against Jake will substantially deprive the Debtor of a primary asset (its owner’s time and attention).  In Plain English, how important is the principal Jake to the Debtor’s operations?  A four-part test is employed to make that determination.

While automatic stay proceedings are usually only available to the Debtor, under unusual circumstances, the Fourth Circuit has held that the Bankruptcy Court can enjoin proceedings against third parties.  In re F.T.L. Inc., 152 B.R. 61 (Bankr. E.D. Va. 1993).  However, where no compelling or unusual circumstances exist, then under §362 the Debtor’s guarantors must file their own bankruptcy petition in order to be protected by the Bankruptcy laws.  Id. at 63. (this also happens often).

A court is only likely to grant an injunction to a third party non-debtor principal in the unusual circumstance that it is evident that the identity of the debtor and the non-debtor third party is so interconnected that it is clear that the creditor is proceeding against the debtor.   Under such circumstances, the court may apply a four-part test and equitably grant an injunction where the court finds that:

  • the plaintiff principal has a greater likelihood of succeeding on the merits;
  • plaintiff principal has shown that lack of relief will result in irreparable injury;
  • an injunction will not substantially harm other interested parties, and;
  • preserving the status quo until the merits of the controversy is decided will serve public interests. Id.

In re F.T.L., the primary secured creditor to a car wash company debtor, secured a judgment lien against the debtor’s guarantors, the plaintiffs. Plaintiffs are the primary owners and guarantors of the car wash and the creditor perfected its lien against plaintiffs’ personal residence.  Id. at 62.  Noting that the collection activities against the owners arose from the car wash’s debt to the creditor, the court applied the four-part test and found that the debtor was likely to succeed on the merits by proposing a confirmable chapter 11 plan; the debtor’s chapter 11 plan would be impossible if the owners were forced to file their own chapter 11 petition; very little harm was likely to come to the creditor if it was enjoined from collection activities against the owner, and; lastly the creditors as a whole were best served if the debtor were allowed to propose a plan for reorganization. Id.  The Court extended the injunction to the owners.

If you own a business and are wondering the same questions,  you should review the facts and circumstances of your workout with your attorney.  I think, by and large, the automatic stay is difficult to extend in Bankruptcy Court.  You have to make a really compelling argument that the principal will be so consumed with his or her own bankruptcy that the Chapter 11 reorganization will suffer.

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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.