April 9, 2009

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Avoiding the Domino Effect

The Moves to Make if Your Supplier or Customer Goes Bankrupt

By Gretta Spendlove

April 9, 2009

It’s the classic story of how “they all come tumbling down.” In the throws of the economic crisis, auto-part manufacturers couldn’t borrow money or buy raw materials in without first being paid for parts they already shipped. The threatened bankruptcies of GM, Chrysler and Ford were driving auto-part makers to their own bankruptcies. “Auto Suppliers Share in the Anxiety,” the New York Times reported in December 2008. While GM, Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers have more than 600,000 workers, all put at risk by the Big Three automakers. Utah businesses also run a risk of getting entangled in the bankruptcies of suppliers, customers or other related companies as a result of the tumbling economy. Here are a few ideas for minimizing the loss: Get good help fast. Bankruptcy laws are complicated, penalties for making the wrong move can be stiff and deadlines for action are often short. As soon as you learn your customer or supplier is facing bankruptcy, consult a bankruptcy lawyer about your options if the sum at stake is substantial. Explore reclamation. You delivered products to your customer on March 10. Your customer files bankruptcy on March 25. You may be able to get the products back if you act quickly. A bankruptcy law provision allows “reclamation” of goods within 45 days after receipt, if the buyer was insolvent when it received the goods. If the buyer goes bankrupt, the written demand for reclamation must be made within 20 days after the bankruptcy filing. Determine the status of your contracts. Bankruptcy law gives debtors limited periods to assume or reject “executory contracts.” In simple terms, executory contracts are agreements that have not yet been completely performed. For instance, an equipment lease on which the debtor still holds equipment and is making payments is an executory contract, as is a software license that a debtor still uses and for which it owes money. You cannot cancel the equipment lease or software license just because the customer goes bankrupt. You must wait the period specified by the bankruptcy laws or by the court (sometimes 60 days, but usually longer), until the debtor either “assumes” the lease or license or “rejects” it. A debtor must bring leases and licenses current and keep them current, if it assumes them. If it doesn’t, you can then cancel the agreement. Determine whether you are a secured creditor. Secured creditors are usually treated better in bankruptcy than creditors without security. Lenders on houses, cars and boats usually take mortgages and security agreements, which give them a preferred status in bankruptcy. Sellers of software, oranges and drugs usually don’t. You can also become a secured creditor by getting a judgment against the debtor before bankruptcy, provided the debtor has enough assets, after considering the claims of other secured creditors, to cover your judgment. The dilemma in deciding whether to sue a financially wobbly customer is that you may get a judgment that will protect your claim, or you may push the customer into a bankruptcy that he wouldn’t otherwise have filed! Comply with the bankruptcy stay. As soon as a customer or vendor files bankruptcy, you must cease collection efforts and all proceedings to obtain your goods. If you persist despite knowing of the bankruptcy filing, you could face large fines. Several years ago, Fleet Mortgage Corporation filed a foreclosure action against the Florida condo of a bankrupt 85-year-old retiree and widower, based on an unsigned court order allowing it to proceed. The court had not, in fact, authorized the foreclosure. The widower’s neighbors found out about the foreclosure and shunned him at the clubhouse. A sympathetic court awarded the widower $40,000 in damages and attorneys fees. Attend the first meeting of creditors. If you are listed as a creditor on a bankruptcy filing, you will receive written notice of the “first meeting of creditors.” That gathering is an excellent place to get information about your customer or supplier’s assets and plans. Anyone can attend and any creditor can ask the debtor, with or without an attorney, questions such as, “What are you doing to protect the equipment you leased from me?” “Is the business still open or are you just trying to sell off assets?” “How soon do you expect to make a decision on assumption of my lease?” Those are all fair questions for the creditors’ meeting. Decide whether to file a proof of claim. In “no asset” bankruptcies, where the debts greatly exceed assets, creditors may be notified not to file a proof of claim. In other bankruptcies, in which the debtor has assets and disputes the amount owed to you, filing a proof of claim can be the difference between getting nothing and a fair settlement. Avoid the domino effect. The Bankruptcy Code is one of the most complex U.S. laws, rivaling the Tax Code. Bankruptcies can be long and frustrating. But, with skilled legal help, businesses can minimize the risk of being pushed into their own bankruptcy as a result of a customer’s or supplier’s filing. Gretta Spendlove is a shareholder with the law firm Durham Jones & Pinegar. She can be reached at gspendlove@djplaw.com.
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