The filing of a bankruptcy case typically precludes an unsecured creditor – such as a trade vendor – from having its prepetition claim satisfied in full. While this general principle holds true in most instances, the Bankruptcy Code provides certain remedies that mitigate the harm to unsecured creditors. Once such remedy arises in Section 546(c), which recognizes valid state law reclamation claims in the context of a bankruptcy case.

The concept of reclamation is rather straight-forward. Subject to the rights of a secured creditor with a security interest in such goods or proceeds thereof, a seller that has sold goods to the debtor in the ordinary course of the seller’s business can reclaim those goods if: (i) the debtor received the goods while insolvent and within 45 days of the commencement of the bankruptcy; and (ii) the seller timely makes a written demand for reclamation. See 11 U.S.C. § 546(c).

The Problem
Reclamation claims for goods sold are subject to prior rights of a secured creditor with a security interest in such goods or the proceeds of such goods. For example, the vast majority of bankrupt business debtors have secured creditors with blanket security interests against all of their assets. Left unsatisfied, unsecured vendors will often find their reclamation claims trumped by the claims of senior secured creditors because the secured creditors’ security interests are prior to the reclamation claimants’ rights. Moreover, the vast majority of bankrupt business debtors who need to fund their bankruptcy cases will typically secure debtor-in-possession (“DIP”) financing and, in many instances, pay off their prepetition secured creditors. As discussed in a recent Delaware bankruptcy court opinion, using DIP financing to satisfy prepetition secured debts may give reclamation claimants an opportunity to prevail on their reclamation claims.

The Case
In In re Rechhold Holdings US, Inc., 2016 WL 4479286 (Bankr. D. Del. Aug. 24, 2016), the debtor secured DIP financing that it used to satisfy its prepetition secured creditors. The DIP lender had no affiliation or relation to the prepetition lender with the prior security interest that impeded the rights of the reclamation claimants. Deviating from past holdings from the Second Circuit1, Judge Mary Walwrath held that the DIP financing, which the debtor used to satisfy its prepetition secured creditors, did not constitute an “integrated transaction,” and allowed the reclamation claims. In rendering her decision, Judge Walwrath concluded that the liens granted to the DIP lender did not relate back to the security interests granted to the debtor’s prepetition secured creditor. Thus, the transaction was not “integrated,”2 and for purposes of the pending reclamation claims, the security interests granted to the DIP lender were not prior to the reclamation claimants’ rights.

The Opportunity
For creditors, a critical lesson to draw from this decision is to closely scrutinize any request for approval of DIP financing. Debtors often seek approval of post-petition financing through their prepetition lenders, claiming they have no other viable alternatives. If a court approves DIP financing made available by a prepetition lender, then the court will likely find that the transaction is integrated and that the post-petition lien relates back to the prepetition security interest. This would effectively defeat any reclamation claim asserted against a customer with a prior secured lender.

However, if the court is presented with alternatives for DIP financing made available by lenders other than the prepetition secured lender, then the integrated transaction conclusion finds itself on shakier grounds. By creating a firm distinction between prepetition and post-petition lenders, reclamation claimants will create an opportunity to have their reclamation claims recognized if the debtor satisfies the prepetition secured lenders with the DIP financing.

1) See In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007); In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003).

2) Courts will decide whether a transaction is “integrated” on a case-by-case basis.  Most courts will conclude that a transaction is “integrated” where there is unity of parties and/or claims – i.e., the prepetition secured lender is the same party that issues the post-petition DIP financing and receives a security interest that is equal to, or greater than, its prepetition security interest.  Courts have also deemed a transaction as “integrated” where the post-petition financing resulted in the simultaneous release of a prepetition lien in exchange for a post-petition lien to secure the post-petition financing.  See In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128, 136 (Bankr. S.D.N.Y. 2003).

Has your customer filed for bankruptcy? Contact Bernstein-Burkley’s experienced team of attorneys to learn how you can maximize your recovery! 412-456-8100

The vast majority of suppliers, vendors, lessors and lenders have experienced the difficult task of navigating a bankruptcy case.  Certain customers file for bankruptcy due to a significant drop in business that impairs their ability to pay their debts as they come due; others may file to stave off aggressive collection actions.  Whatever the cause, the commencement of a bankruptcy case sets in motion a process designed to afford financial relief to the debtor while ensuring that its creditors have an opportunity to receive fair treatment.  Creditors must understand and take certain critical steps in the bankruptcy to guarantee the best possible treatment of their claims.

1.     Recognize the Red Flags.
One of the most important steps for any creditor to take actually arises before the debtor files for bankruptcy.  Creditors must recognize the red flags that often telegraph a bankruptcy filing.  These red flags include the debtor missing payments when due, seeking to renegotiate payment terms, or explaining that payments will resume once business returns to normal.  The debtor may also refuse to discuss the payment of past due invoices or fail to return calls from its creditors.  Finally, collection lawsuits or other legal actions taken by creditors may be the most apparent indicator of an impending bankruptcy.  A creditor that recognizes these precursors can anticipate a bankruptcy file and take the preliminary steps necessary to maximize its recovery.

2.     Who, What, Where, When, Why.
Once you find out that a client has filed for bankruptcy, take note of every detail provided in the initial notices, such as the date the debtor filed and the bankruptcy court where the case is pending.  These details are important, as they trigger various deadlines to which creditors must adhere if they wish to preserve their rights.  For example, if a supplier wishes to assert reclamation rights, it must send a proper notice to the debtor within 20 days of the filing date.  The filing date also sets the 20-day, pre-bankruptcy period that may entitle a creditor to full payment for goods delivered to the debtor during that 20-day period.  The initial filing (called the voluntary petition) may also identify key information about the debtor, such as its address, attorneys, estimated assets and liabilities, and its 20 largest creditors.  Creditors should understand this information and be aware of the issues that quickly arise following the initial filing.

3.     Understand Your Claim.
The type of claim that a creditor has almost always dictates the treatment it will receive.  Secured creditors will often receive either the value of their collateral or will receive relief from stay to repossess and liquidate their collateral.  To that end, secured creditors must understand their loan documents and recognize issues that often arise, such as whether they perfected their security interests in the debtor’s collateral, whether they have priority in a specific piece of collateral, and whether the debtor can adequately protect their interests in the collateral.  Answering these questions will impact the treatment received through the bankruptcy.

Unsecured creditors, such as vendors and suppliers of goods and equipment lessors, must likewise understand their claims and how the Bankruptcy Code will treat their claims.  Since unsecured creditors are almost last in payment priority, they often receive pennies on the dollar for their unsecured claims. To maximize their recovery, unsecured creditors must understand which portions of their claims may earn higher administrative priority.  As noted above, creditors are entitled to be paid in full for goods delivered to the debtor within 20 days of the bankruptcy filing.  Bankruptcy court often require these creditors to file a motion seeking approval and payment of this type of administrative claim.

Additionally, if a debtor relies primarily on the good will of its vendors and suppliers to continue doing business, the debtor may need to seek bankruptcy court approval to pay its “critical” vendors the value of their pre-petition claim to ensure that they continue to do business with the debtor.  As for lessors, the bankruptcy code imposes deadlines on the debtor to assume or reject unexpired leases. If the debtor assumes the lease, it must cure all defaults under the lease and provide adequate assurance of future performance before it can assume the lease.  These topics barely scratch the surface of all of the various rights and protections for secured and unsecured creditors, which is why all creditors must completely understand their claims from the start.

4.     Be Wary of Key Bankruptcy Protections.
Creditors must also be aware of key protections that the Bankruptcy Code affords to debtors after filing for bankruptcy – specifically, the automatic stay.  The Bankruptcy Code automatically imposes a stay, subject to certain exceptions, of all actions by a creditor to collect against a debtor for a pre-petition debt.  One of the most common mistakes a creditor makes immediately after a debtor files for bankruptcy is it violates the automatic stay.  These violations occur in a variety of ways, such as: i) discontinuing utility services on account of an unpaid, pre-petition date; ii) attempting to enforce or collect on a pre-petition judgment; iii) demanding payment for a pre-petition debt; and iv) seizing property that belongs to the debtor’s estate.

If a creditor knowingly violates the automatic stay, the bankruptcy court may impose damages, including sanctions, for the violation.  To avoid the risks associated with violating the automatic stay, if a creditor believes it has grounds to pursue claims against the debtor, the best course of action is to move for relief from the automatic stay.  As with administrative expense claims, bankruptcy courts require a motion setting forth the grounds for seeking relief from stay, which it can only grant after notice to the debtor and a hearing.

5.     Pay Attention:  It’s Not Junk Mail.
One of the most critical mistakes many creditors make at the outset of a bankruptcy case is to disregard important notices from the bankruptcy court, the debtor, and other creditors.  Creditors that receive the initial notice of a debtor’s bankruptcy filing will likely receive hundreds, maybe thousands, of notices throughout bankruptcy case.  Creditors must review these notices, as many include important deadlines that could potentially bar any recovery at all.  For example, bankruptcy court sends out a Notice of the Section 341 Meeting of Creditors, which sets a time and place for creditors to ask the debtor questions about the bankruptcy.  Not only does this notice set the 341 Meeting, it often sets a bar date for filing proofs of claim and for commencing actions to determine the dischargeability of debt.  Missing either of these deadlines could significant impact a creditor’s ability to recover against the debtor.

Many other notices are equally important and may impair the rights of creditors if disregarded, such as motions to authorize use of cash collateral and approve debtor-in-possession financing.  There is simply no way to overstate the importance of reviewing notices received about a bankruptcy case.  Failing to do so may result in an unassailable bar to recovering against the debtor.

To learn more about Bernstein-Burkley’s Bankruptcy and Restructuring Practice Group, click here or call 412-456-8100.

Click Here to View Bernstein-Burkley’s Spring 2016 Newsletter

Included in the newsletter:

• When Extending Credit to a Customer, Begin with the End in Mind
• The Five Minute Legal Master Series: The Appeals Process
• Congratulations to Robert Bernstein who was recently inducted as a fellow by the American College of Bankruptcy
• Bernstein-Burkley was named a Tier 1 law firm by US News – Best Lawyers 2016 “Best Law Firms”
• Four Bernstein-Burkley partners have been recognized by the 2016 Super Lawyers List

Robert S. Bernstein, Esq.
Co-Managing Partner, Bernstein-Burkely, P.C.

It’s what acclaimed author Dr. Steven Covey, in his book 7 Habits of Highly Effective People, told us to do: begin with the end in mind.  He described this habit as one of imagination.  Similarly, when we first think of extending credit to a customer, way back before the first order is signed or before the first application is taken, we have to begin with the end in mind.

What does our credit function seek to accomplish?  What is the contribution of the credit team to the smooth (and profitable) functioning of the business?  Many believe that the credit team is as much the backbone of a business as is the manufacturing team or the sales team.  Unless the business has decided not to lend money, credit must be an early thought in the imagination of the founders.  They must think about how lending to customers can be initiated, calculated, negotiated, documented, facilitated, managed, collected and, yes, litigated.  Beginning with the end in mind in the credit function means making sure that you can collect the credit, even when the customer fails to pay on time, even when the customer seems unable to pay.

Continue reading “When Extending Credit to a Customer, Begin with the End in Mind”

By Kirk B. Burkley, Esq.

A recent decision from the United States Court of Appeals for the Sixth Circuit will likely chill certain collection practices employed by aggressive creditors. In the case of Weary v. Poteat, No. 15-5159, 2015 WL 5712191 (6th Cir. Sept. 30, 2015), the Sixth Circuit reviewed the criminal prosecution exception to the automatic stay and upheld the bankruptcy court’s award of actual and punitive damages to the debtor for the creditor’s violation of the stay.

Continue reading “Creditors Beware: A Restrictive Approach to the Criminal Prosecution Exception to the Automatic Stay”

By Nicholas D. Krawec, Esq., Partner

If you are reading this article, chances are that you are involved in the construction industry as a contractor, subcontractor or material supplier on large Pennsylvania construction projects, and the words “changes to the Pennsylvania Mechanics’ Lien Law” caught your eye.  That’s good, because if indeed you are engaged in the construction industry, you should become familiar with these changes.

Recently, Sections 201, 501.1 and 501.6 of the Pennsylvania Mechanics’ Lien Law were amended or implemented.  To read more details as to the specifics of the amendment, click here. The amendment to Section 201 of the statute adds some definitions that you will need to be aware of when the rest of the amendments take effect by December 31, 2016 (if not sooner).  The “construction notice” identifies certain new notice requirements upon contractors and subcontractors alike (in addition to the notice requirements already imposed by the statute).

Continue reading “Changes to the Pennsylvania Mechanics’ Lien Law Affecting Large Construction Projects”

By Nicholas D. Krawec, Esq., Partner

Naturally, when a creditor refers a claim to an attorney for collection, that creditor is going to be faced with payment of attorneys’ fees, often on a contingent fee basis. A vigilant creditor places an attorneys’ fee provision in his contract documents, which provides that if the debtor defaults, and the claim is placed with an attorney for collection, the debtor is responsible for payment of the creditor’s attorneys’ fees. This is part of the creditor’s efforts to be “made whole” if and when the debt is finally collected.

Continue reading “Be Careful When Claiming Attorneys’ Fees in Lawsuits on Consumer Claims – Remember the FDCPA”