Author: Andrew M. Thaler
1. Automatic stay - The automatic stay goes into effect automatically from the time the bankruptcy petition is filed. Any act, even without knowledge of the bankruptcy, is a technical violation of the stay. The automatic stay is very broad. Any action contemplated by the bank to collect debts, perfect liens, attach property, repossess property, set off accounts, etc. may be subject to the stay. The bankruptcy court may impose sanctions if the bank takes these or other actions with knowledge of the stay.
2. Proofs of Claim - In order to participate in a distribution from the bankruptcy estate as a general unsecured creditor, the bank generally must file a timely proof of claim that sets forth the basis for the debt. The time to file proofs of claim is limited and must be filed before the noticed bar date.
3. Preferential Payments - The law is designed to lessen the likelihood that the debtor will plan to and actually pay certain creditors shortly before the bankruptcy filing. These “preferred” creditors are often “insiders”, (family members and business partners) or certain trade creditors the debtor needs to rely on in the future or other creditor the debtor wants to protect from financial loss. Payments made on old debts to insiders when the debtor is insolvent are recoverable going back one year prior to the bankruptcy petition or 90 days for payments made to non-insiders. If presented with a demand for return of a preference, there are numerous defenses that might apply. Most preference actions, even strong ones, are often settled for less than the demand.
2. Proofs of Claim - In order to participate in a distribution from the bankruptcy estate as a general unsecured creditor, the bank generally must file a timely proof of claim that sets forth the basis for the debt. The time to file proofs of claim is limited and must be filed before the noticed bar date.
3. Preferential Payments - The law is designed to lessen the likelihood that the debtor will plan to and actually pay certain creditors shortly before the bankruptcy filing. These “preferred” creditors are often “insiders”, (family members and business partners) or certain trade creditors the debtor needs to rely on in the future or other creditor the debtor wants to protect from financial loss. Payments made on old debts to insiders when the debtor is insolvent are recoverable going back one year prior to the bankruptcy petition or 90 days for payments made to non-insiders. If presented with a demand for return of a preference, there are numerous defenses that might apply. Most preference actions, even strong ones, are often settled for less than the demand.
4. Compromise - Contested matters in bankruptcy are often settled because the parties’ cost of litigation can be high in relation to the dollars at stake. There is risk of loss for both sides. Attorneys representing a Chapter 11 debtor or Bankruptcy Trustee may be working under an arrangement where they are only paid from what they recover or the estate has limited resources to pay litigation legal fees and costs. The distribution paid to creditors in chapter 11 and 7 bankruptcy cases is historically only a percentage of the amount of their filed claims. These and other considerations often make it easier to settle cases.
5. Liens Generally Survive - Liens against property generally ride through bankruptcy unaffected. This means that even though, for instance, the individual debtor may be discharged from the obligation to pay the underlying debt, the property still stands as security for the loan. However, recent case law has shown that a bank’s failure to object to provisions in a corporate Reorganization Plan could adversely affect the bank’s lien rights.
6. Objections to Discharge - If an individual debtor has committed fraud by inducing the bank to extend credit through use of a false financial statement, the bank could commence an adversary proceeding to have the debt declared non-dischargeable. The time frame to object to discharge is short unless extended by the court. Courts are reluctant to extend the time to object without good cause.
7. Contract Terms can be Modified - In chapter 11 cases the debtor can often modify the terms of the bank’s loan. This may include interest rate, the term, payment amounts and principal. A mortgage on an individual debtor’s residence can generally not be modified in bankruptcy.
8. Reaffirmation Agreements - Reaffirmation agreements must be signed by the debtor and the bank and filed with the court within 60 days after the first meeting of creditors. A reaffirmation agreement signed or filed with the court after the debtor received a discharge is unenforceable. The proper forms must be used and copies of the loan documents filed with the court.
9. Cash Collateral – A chapter 11 debtor is technically prohibited from using the bank’s cash collateral (accounts receivable, proceeds of inventory sales etc.) without permission from the bankruptcy court on notice to the bank. The bank will want to actively monitor its collateral position and participate in cash collateral hearings usually held at the early stages of the case or make its own protective motion to make sure that its collateral is being adequately protected. Unless the court grants the bank a replacement lien on the assets generated from the bank’s pre-petition collateral, the bank’s collateral position will be adversely diminished.
10. Payments from Third Parties – Sometimes an obligor of a bank directs a third party that has no relation to the bank to pay the obligor’s debts directly to the bank. If the party that makes payment to the bank is not contractually obligated to the bank, a creditor or the bankruptcy trustee of the party that makes the payment may seek to recover the payment received as a fraudulent conveyance or other avoidable transaction - particularly if the transaction does not benefit the party making payment. Care should be taken in deciding when to accept third party payments.
Bonus: Don’t Delay Action on Rights - Debtors in bankruptcy are given often the benefit of the doubt upon filing bankruptcy. Chapter 11 debtors seeking to reorganize may have difficulty complying with the rigors of the Bankruptcy Code and Rules. Courts generally provide some initial leeway to the debtor because converting the case to chapter 7 will terminate operations and put employees out of work. Banks can dramatically shorten the time debtors are allowed to remain in default of its obligations by commencing an appropriate motion at the earliest possible date that (i) details the debtor’s failure to comply with the rules and (ii) clearly presents the damages the bank is sustaining by virtue of the debtors deficiencies. Courts are less likely to allow the debtor to stay in bankruptcy when an aggrieved creditor asserts its rights.
5. Liens Generally Survive - Liens against property generally ride through bankruptcy unaffected. This means that even though, for instance, the individual debtor may be discharged from the obligation to pay the underlying debt, the property still stands as security for the loan. However, recent case law has shown that a bank’s failure to object to provisions in a corporate Reorganization Plan could adversely affect the bank’s lien rights.
6. Objections to Discharge - If an individual debtor has committed fraud by inducing the bank to extend credit through use of a false financial statement, the bank could commence an adversary proceeding to have the debt declared non-dischargeable. The time frame to object to discharge is short unless extended by the court. Courts are reluctant to extend the time to object without good cause.
7. Contract Terms can be Modified - In chapter 11 cases the debtor can often modify the terms of the bank’s loan. This may include interest rate, the term, payment amounts and principal. A mortgage on an individual debtor’s residence can generally not be modified in bankruptcy.
8. Reaffirmation Agreements - Reaffirmation agreements must be signed by the debtor and the bank and filed with the court within 60 days after the first meeting of creditors. A reaffirmation agreement signed or filed with the court after the debtor received a discharge is unenforceable. The proper forms must be used and copies of the loan documents filed with the court.
9. Cash Collateral – A chapter 11 debtor is technically prohibited from using the bank’s cash collateral (accounts receivable, proceeds of inventory sales etc.) without permission from the bankruptcy court on notice to the bank. The bank will want to actively monitor its collateral position and participate in cash collateral hearings usually held at the early stages of the case or make its own protective motion to make sure that its collateral is being adequately protected. Unless the court grants the bank a replacement lien on the assets generated from the bank’s pre-petition collateral, the bank’s collateral position will be adversely diminished.
10. Payments from Third Parties – Sometimes an obligor of a bank directs a third party that has no relation to the bank to pay the obligor’s debts directly to the bank. If the party that makes payment to the bank is not contractually obligated to the bank, a creditor or the bankruptcy trustee of the party that makes the payment may seek to recover the payment received as a fraudulent conveyance or other avoidable transaction - particularly if the transaction does not benefit the party making payment. Care should be taken in deciding when to accept third party payments.
Bonus: Don’t Delay Action on Rights - Debtors in bankruptcy are given often the benefit of the doubt upon filing bankruptcy. Chapter 11 debtors seeking to reorganize may have difficulty complying with the rigors of the Bankruptcy Code and Rules. Courts generally provide some initial leeway to the debtor because converting the case to chapter 7 will terminate operations and put employees out of work. Banks can dramatically shorten the time debtors are allowed to remain in default of its obligations by commencing an appropriate motion at the earliest possible date that (i) details the debtor’s failure to comply with the rules and (ii) clearly presents the damages the bank is sustaining by virtue of the debtors deficiencies. Courts are less likely to allow the debtor to stay in bankruptcy when an aggrieved creditor asserts its rights.
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