Whether you sell goods or services, your chance of doing business with a company now or soon to be embroiled in bankruptcy proceedings is probably not as remote as you'd hope it to be. While it may not be your job to keep another business from falling in with the chapter 7 or chapter 11 crowd, it makes sense to limit your exposure to the financial woes of a key customer or supplier.
Protect your business-and improve your bottom line--when collecting from financially strapped vendors or buyers by using the 12 tips described below.
1. Get paid now, not later. Insist on payment on outstanding invoices in the ordinary course and on ordinary business terms. Certain payments on old bills, made within 90 days (or within one year in the case of debtor insiders), prior to a debtor's filing for bankruptcy protection, may later turn into a demand for turnover from the unwitting creditor. If this happens to you, you will be asked to return the payment dollar for dollar, then file a proof of claim for the returned payment. At that point, you will join with debtor's other creditors and . . . wait. Experienced attorneys know how to deal with these claims. Among other strategies is to show how your goods and services provided independent value to the bankruptcy estate, thus offsetting the claimed preference. Alternatively, it may be shown that the questioned payments were made in the ordinary course of business, and received within typical business terms of the parties or industry.
2. Show me the money. Get paid smarter. Do business with distressed companies on your own terms: cash on delivery, if permitted by custom and trade or by contract. Payment terms such as cash-on-delivery, cash-before-delivery, special collateral accounts, letters of credit, consignments, and other methods may not only provide some comfort you will be paid for goods and services provided to buyer, but also that debtor will be unable to later claim the payments are recoverable as preferences. When you negotiate a business deal, structure the payments so you can tighten the payment terms or shift to cash-on-delivery or cash-before-delivery under specified circumstances, such as failure to pay on time, or other breaches by your customer, buyer or supplier.
3. Develop a Plan B. Establish contract provisions permitting you to tighten the noose when payment terms or financial benchmarks are not met. If you suspect there may be problems with the other party's performance, move to cancel the contract before your customer or supplier files for bankruptcy protection. If you do not move quickly enough and the other party becomes a bankruptcy debtor, your later efforts to close off relations will be subject to bankruptcy court review and, perhaps, nullification. Care must be taken; even contract provisions providing for automatic contract cancellation when one party seeks bankruptcy protection are likely to be disregarded as "ipso facto" clauses.
4. Don't dawdle. Understand your state-law rights under the applicable Uniform Commercial Code to determine if you still have time to reclaim goods shipped to your buyer. For example, the Uniform Commercial Code allows a seller to "reclaim" goods shipped within 10 days under certain circumstances where seller discovers buyer is insolvent. The rules are arcane, non-intuitive, and often complex; seek out an attorney with experience in creditor's rights enforcement, and recovery of fraudulent conveyances and hidden assets. Consignments are a special case altogether: typically a UCC-1 financing statement should be filed when and where the goods are shipped. Again, get solid advice and competent legal representation early.
5. Control the deal. Structure contracts such as technology licenses so that you maintain control as the licensor. By doing so you may be able to compel debtor-licensee to "assume or reject" the contract within a certain time period. An executory contract, generally speaking, is an agreement under which some performance remains due on both sides. Almost all license agreements will be considered executory contracts. Under certain circumstances, debtor-licensee may be able to assume a license and then transfer it to a competitor or potential customer of yours, even though transfer may be expressly prohibited under the pre-bankruptcy contract. So push for a quick decision and compel debtor to pay currently. Be mindful of so-called "boilerplate" contract provisions, such as forum selection clauses, waiver of notice, and compulsory arbitration provisions, among others. These seemingly innocent terms may indeed be very important, as well as negotiable. If they make a difference to you, request changes.
6. Protect IP. Structure technology licenses where you are the licensee so you keep the benefit of the license. Anticipate that once your licensor rejects the license, it will likely walk away from its payment and performance obligations under the license. Make sure before signing the license you have provided for contingencies. For example, make certain you have placed the intellectual property, patent or trademark, secret formula, or source code with a third-party neutral under an appropriate escrow agreement.
7. Dump the lease. When possible, move quickly to terminate a commercial lease before tenant files for bankruptcy court protection. Aggressively move to exercise your lease rights in state landlord and tenant court. Anticipate and plan ahead. If a commercial tenant is stripped of all interests in its nonresidential lease because the lease was over before the bankruptcy case began, debtor may have nowhere to go with no valuable lease asset to assume or to assign. If so, the owner may be able to recover possession with little or no protracted (and expensive) legal proceedings in a debtor-friendly bankruptcy court.
8. Hire talent. Engage a savvy attorney with business bankruptcy experience. Do so early. Though no one wants to throw good money after bad, experienced counsel should be able to help determine whether you may expect to receive some recovery from debtor, and how best to maximize your claim. Always watch your back, though, or you may later be targeted by debtor or its trustee to defend against bankruptcy court litigation on one of several theories aimed at restoring money to the bankruptcy estate for the benefit of creditors in general. This tactic may strike when you least expect it, and typically seeks return of funds collected legitimately in the days just before debtor filed. While adversary proceeding lawsuits cannot be avoided altogether, an experienced bankruptcy attorney can help you guide you to regain control and level the playing field.
9. Raise your hand. In a chapter 11 reorganization case, consider contacting the Office of the United States Trustee and volunteer to sit on debtor's official committee of unsecured creditors. As a member of the committee, you will have access to debtor's financial information and to the services of the committee's court-appointed counsel, who may often provide insight into the case and into debtor's ability to emerge from bankruptcy and pay creditors a higher dividend.
10. Be proactive. File a proof of claim for any debts owed to you. Support your claim with pertinent documents. Place the world on notice you claim an interest in the bankruptcy estate. Correctly complete the proof of claim and have your attorney monitor the bankruptcy case docket to determine when and whether you will likely receive a dividend. Get help if you need it, but pay close attention and follow the rules carefully. Do not miss the claims filing deadline.
11. Do your homework. When dealing with a debtor-landlord, make sure maintenance, utilities and janitorial services are available from third-party sources other than landlord. The bankruptcy code gives tenant of a debtor-landlord the option of staying with the lease even if debtor-landlord rejects it. Be aware debtor-landlord will probably not be required to provide ancillary services to the holdover tenant, who may face operational problems in obtaining those services elsewhere if this contingency is not fully considered and planned for in advance of lease rejection.
12. Start bidding. Buying assets at a bankruptcy auction sale may make sense. Again, ask questions and do your research. Consider acquiring debtor's business or all or part of its assets for pennies on the dollar, often free and clear of liens. The good news is it is often difficult for other creditors to later contest the sale of assets once "blessed" by the bankruptcy court and creditor's committee after notice and a hearing, or otherwise authorized by state or federal law. Carefully review the court notice and any other published terms of sale, bidding rules, and buyer's premiums, to avoid unpleasant surprises. Retain an experienced bankruptcy attorney to ask the questions you may not know to ask. While you run the risk some competing bidders may come forward and bid up the price, often the first bidder has a strategic advantage, having already completed due diligence. This added business intelligence often translates to scoring assets at values far below replacement cost or going-concern value.
About Richard E. Weltman
Richard E. Weltman is a member of Weltman & Moskowitz, LLP, a law firm concentrating in creditor and debtor rights, business bankruptcy, contract disputes, shareholder's rights, arbitration, business litigation, technology licensing, and buy-sell transactions, among other matters. His firm serves clients throughout New York and New Jersey. To learn more, visit www.weltmosk.com or call 212.684.7800 or 201.794.7500. The author thanks William S. Wolfson, a member of the New Jersey Bar, who created an earlier version of this article.
