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Publication Category: Creditors' Rights

A Short Series on Reclamation for Credit Managers, Part 4: CASH, LIEN OR CLAIM?

Part 4: CASH, LIEN OR CLAIM?

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

V. RECLAMATION RIGHTS VS. SECURED CREDITORS
AND/OR GOOD FAITH PURCHASERS

A seller seeking reclamation must contend with two common hurdles to recovery. One is a prior secured creditor with a floating lien on the assets of the debtor. The second hurdle is the good faith purchaser, where a debtor no longer has the goods because they were sold to a good faith purchaser prior to the reclamation demand. Even Section 2-702(3) of the U.C.C. provides that a seller’s reclamation rights are “subject to the rights of a buyer in the ordinary course or other good faith purchaser…” Since secured creditors are considered good-faith purchasers pursuant to Sections 1-201(32) and (33) of the U.C.C., a seller is unable to reclaim the physical possession of the goods against either a secured creditor or a good faith purchaser.

Recent case law has all but eliminated a seller’s right to reclamation if there is a prior secured creditor with a floating lien on the assets of the debtor. See In re Dana Corporation, 2007 Bankr. LEXIS 1466 (Bankr. S.D. NY 2007). In Dana Corp., even though the Debtor’s assets had significant equity above the floating lien of its pre-petition secured lender, the Court held that the plain language of Section 546(c) rendered the reclamation claims valueless.

Next – Part 5: Code v. Code

A Short Series on Reclamation for Credit Managers, Part 3: HOW IT WORKS

Reclamation for Credit Managers, Part 3: HOW IT WORKS

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

III. HOW IT WORKS

The first thing a creditor should do when it learns of a bankruptcy (or other indication of insolvency) is look to see if it has any shipments which were received by the customer in the last 45 days. If there are, sirens should go off, bells should ring and flares should shoot up into the sky! When in doubt, send the notice! Delaying, even a day, can cost your company valuable rights. If you are wrong, and a reclamation notice is inappropriate, there is no downside! The worst that happens is you wasted some time and some money. There is no penalty.

Unlike the UCC Section 2-701, which requires that a demand of unspecified form be made for reclamation, under the Bankruptcy Code, the demand must also be in writing. The written demand must explicitly state that it is “asserting the right of reclamation” and should probably also note that the reclamation is being claimed under 11 U.S.C. Section 546 and applicable state law, in furtherance of explicitly asserting the reclamation rights. In addition, the writing should reflect what items or shipments are the subject of the reclamation. That way, vagueness of the demand does not raise questions of whether items being reclaimed were within the window of reclamation.

The mailbox rule applies to this section. As long as the demand was made in a commercially reasonable manner, it is effective on dispatch. A Telex has been held to be sufficient as a writing and another case held that the demand need not be by registered or certified mail to be effective as a written demand, though for issues of proof, it may not be a bad idea to do so. A hand delivered written demand has been held to be sufficient. Although no reported case was found to discuss fax or e-mail notice under Section 546(c), faxes are generally considered to be sufficient as “writings” under the UCC. However, the use of these “instantaneous” methods is not relevant in terms of time restrictions for making the reclamation demand, because of the employment of the mailbox rule.

Next – Part 4: Cash, Lien or Claim?

A Short Series on Reclamation for Credit Managers, Part 2: RECLAMATION AND BANKRUPTCY

Part 2: RECLAMATION AND BANKRUPTCY

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

I. RECLAMATION AND BANKRUPTCY

Sometimes, the reclamation demand is occasioned by the customer filing a Voluntary Petition for Relief under Chapter 11 of the U.S. Bankruptcy Code. Please note that once a bankruptcy case is initiated, Section 546(c) provides the exclusive remedy for a seller who is seeking to reclaim his goods. Therefore, once a debtor initiates a bankruptcy case, a seller must establish his right to reclaim the goods pursuant to 11 U.S.C. Section 546(c) of the Code.

A seller’s reclamation rights arise under Section 546(c) of the Code only if the seller has a right to reclaim under the non-bankruptcy law (generally the U.C.C.) of the state where the goods were sold. In addition to the nonbankruptcy law requirements, a seller’s failure to comply with the additional requirements of Section 546(c) will terminate his reclamation rights, regardless of compliance with more liberal requirements of the state’s nonbankruptcy laws.

II. SECTION 546(C)

11 U.S.C. Section 546(c) states:

(c) Except as provided in subsection (d) of this section and in section 507©, and subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof, the rights and powers of the trustee…are subject to any the right of a seller of goods that has sold goods to the debtor, in the ordinary course of such seller’s business, to reclaim such goods if the debtor has received such goods while insolvent, within 45 days before the date of the commencement of a case under this title, but

(1) such a seller may not reclaim such goods unless such seller demands in writing reclamation of such goods —

(A) not later than 45 days after the date of receipt of such goods by the debtor; or

(B) not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case.

(2) If a seller of goods fails to provide notice in the manner described in paragraph (1), the seller may still assert the rights contained in section 503(b)(9)

Section 546(c) is straightforward and is similar (although narrower) than Section 2-702(2) of the U.C.C. and the case law relating to Section 546(c) is well-defined. Case law reduced Section 546(c) into the five basic elements which give rise to a seller’s reclamation rights. These elements are as follows:

1. The seller sold goods to the debtor on credit;

2. The sale of goods was in the ordinary course of business of both the debtor and the seller;

3. The seller delivered the goods at a time when the debtor was insolvent, as defined by the Bankruptcy Code;

4. The seller made a written demand for return of the goods within 45 days (or 20 days if the 45 day period had not yet expired when the Petition was filed) after the goods were delivered to the debtor;

5. The debtor had possession of the goods at time of the written demand or the goods were not in the debtor’s possession in the ordinary course of business or the goods had been sold to a good-faith purchaser at the time of demand.

Next – Part 3: How It Works

A Short Series on the Disappearing Debtor – Conclusion: What Creditors Can Do

PART 4: Conclusion: What Creditors Can Do

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

What happens when a business debtor closes up shop one day only to appear the next day under a slightly different name without going through bankruptcy? How does that happen and what do creditors do?  We hope you have enjoyed our short series on the Disappearing Debtor.

To answer that question, we need to review what ownership is, how debt is created and whether creditors have rights to attack property in a name other than the original customer. We attempt to do so in this four-part series. Should you have specific questions, please contact Bob Bernstein at bob@bernsteinlaw.com.

Sometimes, there is nothing creditors can do, practically. There are remedies, which we will discuss here, but the cost may not be reasonable for an individual creditor to undertake.

When your customer (debtor) closes down and reappears a few hours, days or weeks later in a slightly different form, move fast. While there may be a two-year (or longer) Statute of Limitations on fraudulent transfers in many states, there is a practical limitation. If your debtor is a “bad guy,” there is a good chance that this new business may disappear and reappear in yet another form. The longer it goes, the harder it gets. If there are actual assets of the customer in the hands of the new business, it is easier to trace. If time allows the business to sell the inventory and buy new or turn over the customer list or something like that, it becomes more difficult.

Assuming cost is not an issue, get immediately to your counsel to review the situation. There are options. The simplest thing may be to sue the customer and get a judgment. Once you obtain a judgment, you may be able to attach or levy upon assets in the new entity on the theory that they still belong to the old entity. Of course, if they are both sole proprietorships of contain the same partners, it is pretty much a “no-brainer.” If ownership is not identical, it may take some work, but you should be getting someone’s attention by the action.

Another option is to sue the new entity to recover the fraudulent transfer. This is an action directly against the current owner of the assets. In that action, one goal is to have the Court order the transferee to return the property to the customer. Another is to end up with a judgment against the new entity (which now presumably has assets). Once obtained, that judgment can be collected from the business.

A third way of approaching it would be to get together the necessary number of creditors to file an Involuntary Bankruptcy against the customer. Once an Order for Relief is entered and a Trustee appointed, the Trustee should be able to be convinced to use his powers to go after the property in the hands of the new business. While this may be more powerful and, thus, more effective, it is an action on behalf of all creditors, not just those bringing the Petition. The benefits, after expenses, are shared by all creditors.

Whatever the remedy you choose, it is far easier if you, the creditor, are diligent and watchful over your customers. Have a credit policy that is effective enough to learn of these sorts of transfers promptly. It does little good to learn about them six months or a year after they occur. At that point the horse is not only out of the barn, but has left the pasture!

A Short Series on the Disappearing Debtor – Fraudulent Transfers

PART 3: Fraudulent Transfers

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

What happens when a business debtor closes up shop one day only to appear the next day under a slightly different name without going through bankruptcy? How does that happen and what do creditors do?

To answer that question, we need to review what ownership is, how debt is created and whether creditors have rights to attack property in a name other than the original customer. We attempt to do so in this four-part series. Should you have specific questions, please contact Bob Bernstein at bob@bernsteinlaw.com.

When we talk about a fraudulent transfer, we generally do not mean a “criminal fraud.” Usually, a fraudulent transfer occurs when a debtor intends to hinder, delay, or defraud a creditor, or transfers property under certain conditions to another person without receiving reasonably equivalent value in return. The classic case is the fellow who transfers his car to his cousin for $1.00 (or no consideration at all), thinking he will be able to avoid his creditors. Most of us know that such a transfer can be avoided (reversed) if attacked within the appropriate Statute of Limitations.

Other examples of fraudulent transfer include transfers of business inventory or assets to a third person (even if that is a corporation “owned” by the original debtor) or even that “sale” of assets for less than their fair value. If the business doesn’t have any creditors, then there are probably no fraudulent transfers. In other words, this generally only works if the customer is in debt when the transfer is made. Although they are not our topic here, even seemingly innocent transfers can be fraudulent (and be avoided by creditors). If a couple transfers property into a trust for the benefit of their children while they are indebted, there are circumstances where creditors may be able to get to the money in the trust, since it was transferred without receiving equivalent value in return.

The concept of fraudulent transfers also is found in many bankruptcy situations, where the Trustee (or the Official Creditors’ Committee in the Chapter 11) can invoke the law of fraudulent transfers to recover assets for the benefit of the Estate.

Next – Conclusion: What Creditors Can Do

Sample Bylaws of an OFFICIAL UNSECURED CREDITORS’ COMMITTEE

SAMPLE

BYLAWS OF THE
OFFICIAL UNSECURED CREDITORS’ COMMITTEE
IN THE CHAPTER 11 CASE OF

Case No. ________________

Pending in the

UNITED STATES BANKRUPTCY COURT
___________________ DISTRICT OF ________________________

(the “Court”)

Committee Counsel: Bernstein-Burkley, P.C.
707 Grant Street
Suite 2200 Gulf Tower
Pittsburgh, PA 15219
(412) 456-8100

TABLE OF CONTENTS

ARTICLE I
Name

ARTICLE II
Purpose

ARTICLE III
Committee Membership

ARTICLE IV
Officers

ARTICLE V
 Duties of Officers

ARTICLE VI
Subcommittees

ARTICLE VII
Special Subcommittees

ARTICLE VIII
Meetings

ARTICLE IX

Amendments of By-Laws

CERTIFICATION

BY-LAWS OF THE
OFFICIAL UNSECURED CREDITORS’ COMMITTEE
IN THE CHAPTER 11 CASE OF

_______________________________________

Case No. ________________

Pending in the UNITED STATES BANKRUPTCY COURT for the ___________________ DISTRICT OF ________________________ (the “Court”)

ARTICLE I

Name

This Committee shall be known as the Official Committee of Unsecured Creditors and is referred to in these by-laws as “Committee.”

ARTICLE II

Purpose

The purpose of the Committee is to represent the interests of creditors holding unsecured claims in the Chapter 11 case of ___________________________ and be performing such duties provided for in 11 U.S.C. § 1103(c) as the Committee deems appropri ate.

ARTICLE III

 

Committee Membership

(1) Appointment: The members of the Committee shall be those persons appointed by the United States Trustee or by the Court.

(2) Ex-Officio Members: The ex-officio members, if any, of the Committee, shall be those persons appointed by the Court or the United States Trustee as such, or those persons appointed by the Committee itself by a unanimous vote at a meeting attended by a quorum. Ex-officio members shall have all of the rights and privileges of other members, but shall not be entitled to vote on any matter before the Committee. The presence or absence of an ex-officio member shall not be considered in determining the existence of a quorum or a majority for any Committee purpose.

(3) Representatives: Each member shall designate a primary representative and may designate an alternative representative and an attorney or other professional to attend and participate in Committee and subcommittee meetings, and to exe rcise all the member’s powers. A member may change its designated representatives at will by giving written notice of any such change to the chair of the Committee, with copies to the Committee secretary and the Committee Counsel. An Official List of th e representatives, their addresses, telephone numbers and fax numbers will be maintained by the Secretary and/or Counsel and will be distributed to all members after each amendment.

(4) Proxies: A member of the Committee may, by written proxy, authorize any other member of the Committee to vote on its behalf and in its absence, with respect to any specific issue or with respect to all matters which may arise at a C ommittee or subcommittee meeting.

(5) Vacancy: If a member resigns or is removed, the Committee Counsel shall, as soon as practicable, notify the United States Trustee. When appointed, any replacement member shall have all the rights and duties of an original member, b ut shall not act on any subcommittee until appointed thereto by the chair.

(6) Resignation: A member of the Committee may resign by sending a written resignation letter to the Committee chair, with copies to the Committee secretary (if one has been chosen) and the Committee Counsel. The resignation shall be e ffective as of the date of the resignation letter and no formal acceptance of the resignation is required.

ARTICLE IV

Officers

The only required officer of the Committee shall be a chair. The Committee may elect a vice-chair and a secretary if members are willing to serve and the size of the case justifies additional officers. Each officer is to be elected by a majority vote of the Committee and each to serve until replaced by a majority vote of the Committee. The chair and vice-chair shall be the primary representatives of the members of the Committee. The secretary may, but need not, be a primary representative of a member of the Committee.

ARTICLE V

Duties of Officers

(1) Chair: the Chair shall:

  1. Convene or direct Committee Counsel to convene meetings of the Committee, or authorize the Committee to convene meetings as necessary.
  2. Preside at the meetings of the Committee.
  3. Direct Committee Counsel to have agendas prepared for the meetings of the Committee.
  4. Appoint appropriate subcommittees.
  5. Serve as ex-officio member of all subcommittees to which the chair is not appointed as a member.
  6. Perform such other duties as may be delegated to the chair by the Committee which are not inconsistent with these by-laws.

(2) Vice-Chair: The vice-chair shall:

  1. Perform all duties of the chair in the absence of the chair.
  2. Perform such other duties as may be delegated to the vice-chair by the Committee and are not inconsistent with these by-laws.

(3) Secretary: The secretary (or Committee Counsel in the event that a secretary is not elected) shall:

  1. Prepare and distribute in advance of each meeting an agenda for each meeting of the Committee and subcommittees.
  2. Notify members of meetings of the Committee and subcommittees.
  3. If requested by the chair, make the physical arrangements appropriate for meetings of the Committee and subcommittees.
  4. Cause attendance rosters for meetings of the Committee and subcommittees to be completed, and retain all attendance rosters.
  5. Take, transcribe, and distribute (together with a copy of the attendance roster), the minutes of each meeting of the Committee and subcommittees to the members of the Committee, to the professionals employed generally by the Committee and to such othe r persons as the Committee may direct.
  6. Distribute such notices and materials as directed by the chair.
  7. Perform such other duties as may be directed by the Committee and which are not inconsistent with these by-laws.

ARTICLE VI

Subcommittees

(1) Generally: If the Committee determines that its work would be facilitated thereby, the Committee may, by majority vote, from time to time, establish one or more subcommittees.

(2) Appointment: Each subcommittee shall consist of two or more members appointed by the chair and shall be presided over by a subcommittee chair selected by the Committee chair.

(3) Powers and Duties: Subject only to (1) the basic responsibilities of members of the Committee which may not be abdicated and (2) the provisions of ARTICLE VII of these by-laws, each subcommittee so established shall have those dutie s and may exercise those powers delegated by the Committee to such subcommittee.

Meetings: Notices of, and procedures for, meetings, and requirements for quorums, shall be as provided by these by-laws or, in the absence of provision herein, as prescribed by the chair of each subcommittee. Meetings of any subcommi ttee may be called by the chair or any two members of the subcommittee.

ARTICLE VII

Special Subcommittees

(1) Establishment of Special Subcommittees: In addition to any other subcommittees which may be established by the Committee, there shall be established the following subcommittees:

  1. Affiliate “A.”
  2. Affiliate “B.”
  3. Affiliate “C.”
  4. Holders of Subordinate Claims.

(2)Membership: Membership on the above special subcommittees relating to affiliates shall, insofar as practicable, consist of persons holding unsecured claims against the above affiliates of _____________________________ who are members of the Committee; provided, however, that at least one member of the Committee who does not have a claim against any of the above affiliates shall be a member of each special subcommittee relating to an affiliate. Each special subcommittee shall be compo sed of not more than five (5) members. Each special subcommittee shall have full access to information and advice from the professionals employed by the Committee.

(3)Resolutions: Notwithstanding any other provisions in these by-laws, any resolution adopted by any of the aforementioned special subcommittees shall be submitted to the Committee for consideration. Any such resolution may be adopted b y a simple majority vote of the Committee. Any such resolution may be vetoed by the vote of seventy-five percent (75%) of the members of the Committee present and voting at duly called and conducted meeting of the Committee.

(4)Employment of Special Counsel: If the Committee does not adopt or veto a resolution of one of the above special subcommittees, the Committee shall, at the request of the appropriate special subcommittee, apply to the court for authori ty to employ special counsel to represent the position of the appropriate special subcommittee in connection with the subject matter of such resolution.

ARTICLE VIII

Meetings

(1) Place of Meeting: Regular or special meetings of the Committee shall be held at any place which is designated from time to time by the Committee.

(2) Regular Meetings: Regular meetings of the Committee may be held without call or notice, at such dates, times, and places as may be fixed by the Committee.

(3) Special Meetings: Special meetings of the Committee for any purpose or purposes may be called at any time by the chair or any two members of the Committee.

(4) Notice: Special meetings of the Committee shall be held upon at least (5) business days notice by first class, certified mail, or forty-eight (48) hours notice, given personally or by telephone, telecopier, telex, or other similar means of communication. Any such notice shall be addressed or delivered to the primary representative (or in his/her absence, to the alternative representative) of each member at the address shown on the Committee roster. Notice by mail shall be deemed to have been given at the time a written notice is deposited in the United States mail, certified, postage prepaid. Any other written notice shall be deemed to have been given at the time it is personally delivered to the recipient or actually transmitted by the person giving the notice by electronic means, to the recipient. Oral notice shall be deemed given at the time it is communicated in person or by telephone to the recipient.

(5)Waiver of Notice: Notice of a meeting need not be given to any member whose representative signs a waiver of notice or a written consent to the holding of the special meeting, whether before or after the meeting, or whose representat ive signs an approval of the minutes thereof, or attends the meeting without protesting prior thereto or at its commencement the lack of notice to such member. All such waivers, consents, and approvals shall be made a part of the minutes of the special m eeting.

(6)Participation in Meetings by Conference Telephone: Representatives of members of the Committee may participate in a meeting of the Committee, or any subcommittee thereof, through the use of a conference telephone, so long as all part icipants in such meeting can hear and communicate with one another.

(7)Quorum: Fifty percent (50%) in number of the members of the Committee, or of any subcommittee, as the case may be, present by a duly authorized representative as provided in paragraph (3) of ARTICLE III of these by-laws, constitutes a quorum of the Committee or of a subcommittee for the transaction of business at a meeting, except to adjourn as provided in paragraph (9) of this ARTICLE VIII. Except as otherwise required by these by-laws, every act or decision done or made by a major ity of the members at a meeting duly held at which a quorum is present shall constitute the act of the Committee or subcommittee. A meeting at which a quorum was initially present may continue to transact business notwithstanding the withdrawal of members, if any action taken i s approved by at least a majority of the required quorum for such meeting.

(8)Attendance at Meetings: Meetings of the Committee or of any subcommittee may be attended by the duly authorized representative and attorneys of members, the secretary (if not a member), and professionals employed by the Committee, pr ovided that, by majority vote of the Committee or subcommittee, any person may be invited to attend any meeting or portion thereof as the guest of the Committee or subcommittee.

[Alternative (8) Attendance at Meeting: Meetings of the Committee, or of any subcommittee, shall be open to any creditor of the class whose interests are represented by the Committee, any other party in interest in the Chapter 11 case (and counsel), subject to the right of the Committee to admit other persons, and subject to the r ight of the Committee to exclude any non-members from any meeting or portion thereof as to which the Committee determines that attendance by any such non-members and the resulting dissemination of the information to be considered or the action to be taken would be contrary to the best interests of the class of creditors represented by the Committee, or would breach any agreement, express or implied, of confidentiality with respect to the matters to be considered at such meeting.]

(9)Adjournment: A majority of the members present by a duly authorized representative as provided in paragraph (3) of ARTICLE III of these by-laws, whether or not a quorum is present, may adjourn any meeting of the Committee or a subcom mittee to another time and place. If a meeting is adjourned for less than twenty-four (24) hours, notice of the time and place of holding the adjourned meeting need not be given to absent members. If a meeting is adjourned for more than twenty-four (24) hours, reasonable notice of the time and place of holding the adjourned meeting shall be given to the members who were not present at the time of the adjournment.

(10)Action Without a Meeting: Any action required or permitted to be taken by the Committee or any subcommittee may be taken without a meeting if a majority of the members consent to such action in a telephone poll. A good faith effor t must be made to reach all members before tallying the “vote.” Such consent shall have the same effect as a vote of the Committee or subcommittee and a record thereof shall be kept by the secretary or counsel in the same manner as minutes or the meeting s of the Committee or any subcommittee. Any action required or permitted to be taken by the Committee or any subcommittee may be taken without a meeting and without a poll if the chair or, in the absence of the chair, the vice-chair, and Committee Counse l determine that an emergency exists justifying such action without a meeting. The statement of the circumstances constituting the emergency shall be signed by the chair or vice-chair and/or Committee Counsel, and a record of the action taken shall be ke pt by the secretary or Committee Counsel in the same manner as minutes of the meeting of the Committee or any subcommittee.

All of the above notwithstanding, Committee Counsel shall be authorized to act in accordance with a proposed course of action discussed in a memo to the members of the Committee, provided that no member of the Committee raises an oral or written objection to Committee Counsel with respect to the proposed course of action within the time period provided for making such an objection as discussed in the relevant memo. At least seven days to object will be provided from the date appearing on the face of the memo in the event that this means of conducting Committee business is utilized.

(11)Dissemination of Minutes and Other Material: Minutes of meetings of the Committee and copies of reports and other significant written information generated or obtained by the Committee, or prepared for the Committee by its counsel or accountants, shall be provided by the secretary or by Committee Counsel in the absence of a secretary to all creditors of the class represented by the Committee who make written request to the secretary therefor; provided, however, that no such minutes or other material shall be provided if, in the judgment of the Committee, the dissemination of such minutes or other material would be contrary to the best interests of the class of creditors represented by the Committee or would breach any agreement of confidentiality with or relating to the source or subject of any material.

ARTICLE IX

Amendments of By-Laws

These by-laws may be amended only be the vote of a majority of the members of the Committee.

CERTIFICATION

 

The undersigned certifies that he is the duly elected and acting chair of the _______________________________________ Unsecured Creditors’ Committee and that the foregoing is a true and correct copy of the by-laws duly adopted by the Committee at a meeting of the Committee held on the ________________________________, 199__. Dated:____________________ ____________________________________
Chair:____________________

 

FOOTNOTES

 

1. This sample By-Laws was primarily derived from a sample found at § 9.51, pages 9-20, et. seq., in Sulmeyer, Handbook for Creditors’ committees,(Matthew Bender & Co., Inc., 1990).

Improve Chances of Payment from a Risky Customer

By Nicholas D. Krawec, Esquire
Bernstein-Burkley, P.C.

While granting credit to customers is a necessity for doing business, it is always a risk. You, as a small business owner, must look for ways to minimize that risk and improve the likelihood of receiving payment from customers. The methods detailed here are the most common ones on the road to payment.

Ways to improve your chances of receiving payment:

  • Credit and sales components must work cooperatively. Credit managers are, and must be, the sticklers for making an evaluation of the customer’s background and creditworthiness. Sales people, while they fear offending the customer and possibly losing the sale, must reconcile themselves to the necessity of credit checks.
  • Reach into as many of the debtor’s pockets as possible by:
    1. Getting the written personal guaranties of payment of principals of the debtor company including partners, shareholders and spouses. Agreement of the principals’ spouses is particularly important since Pennsylvania law adopts the concept of “tenancy by the entireties,” where creditors of only one spouse cannot ordinarily attach jointly held marital property to settle only one spouse’s debts.
    2. Retaining a security interest in the various assets of the debtor company. Enter into a security agreement with the debtor which gives you a security interest in not only the goods you sell the debtor, but possibly also in inventory, equipment, furniture, fixtures, accounts receivable, etc. Because secured creditors generally receive payment before unsecured creditors, your security interest in the personal property of the debtor enhances your position if the debtor files bankruptcy. Before negotiating and signing a security agreement, consult with an attorney; this procedure can be fraught with pitfalls.
    3. Including with the credit application, or as part of the sales agreement, a confession of judgment clause. By agreeing to the clause, the debtor agrees beforehand that if he defaults, a judgment may be entered against him without trial. As a creditor, you could then file a complaint in confession of judgment in any court of record and issue an execution against the debtor’s business assets.

A confession of judgment appears on any credit report or property search pertaining to the debtor and acts as a lien against real estate owned by the debtor in the county where the judgment is recorded, until it is stricken by the court or satisfied. Such a lien could hinder the debtor’s efforts to obtain future credit, and that possibility may, in itself, force the debtor to remit payment.

Security, whether through a security agreement in personal property or a confession of judgment, should be obtained at the outset of your dealings with the debtor—when his business is going well, and he is optimistic, and when he needs your product and/or service. After he incurs debt with you, and probably with other creditors, he will feel too vulnerable to sign anything.

And if that doesn’t work?

If you have taken these precautions and the debtor still doesn’t pay, turn to the legal process. If you have a confession of judgment executed by the debtor, contact your attorney, have the judgment entered and issue an execution against the debtor’s business assets and business property.

If you do not have any of the above-listed protection but you do have a debtor in default, you must file suit to obtain a money judgment, in which case, it becomes a race to the courthouse with other creditors. There is also the possibility of collecting nothing because you did not have the proper credit security.

If you think the debtor may have improperly dealt with business assets or transferred assets to friends or family for little or no consideration, check with the debtor’s other creditors. It may be worthwhile to file an involuntary bankruptcy against the debtor if he has also defaulted with other creditors. This approach gives you the resources and power of a bankruptcy trustee to find out what happened to the assets of the debtor, and perhaps to undo (i.e., set aside) the improper transactions.

Again, it is best to consult experienced creditors’ rights or bankruptcy counsel if you find yourself in the situations described here.

Remember, you can minimize your risks when granting credit to a customer, by keeping a watchful eye on the debtor and his business operations.

Whatever the debtor can do to forestall his “day of reckoning” puts money in his pocket—your money. Whatever you can do to obtain security and leverage to accelerate the debtor’s “day of reckoning” puts money in your pocket.

Background Information for Chapter 11 Committees of Unsecured Creditors

INTRODUCTION

This booklet was written for the purpose of providing credit managers and other persons who serve on creditors’ committees with general information on the Chapter 11 process and on the operation and function of Chapter 11 Committees of Unsecured Creditors within that process.

This booklet should not be relied upon as legal advice. Practice and procedure are different from jurisdiction to jurisdiction and from court to court. The facts of any particular case are extremely important in determining the legal strategy to be pursued. In the event that any question should arise in the context of any bankruptcy case, it is recommended that committee counsel be consulted.

TABLE OF CONTENTS

I. THE COMMITTEE OF UNSECURED CREDITORS

A. Rationale for Formation of Committee
B. Formation of Committee
C. Adding and Deleting Members
D. Resignation of Member
E. Fiduciary Responsibility of Committee Members
F. Powers and Duties of Committee
G. By-Laws
H. Retention of Professionals
I. Reimbursement of Committee Expenses
J. Termination of Committee
K. Qualified Immunity of Committee Members

II. BUSINESS ISSUES IN A TURNAROUND

A. Distinguishing Between Legal and Business Issues in a Chapter 11
B. The Turnaround as a Distinct Business Strategy
C. Stages of a Turnaround
D. Stage I – the Chapter 11 Filing and Stabilization
E. Stage II – Situation Analysis
1. Determination of Operational Viability
2. Evaluate Liquidation Value
F. Stage III – Strategy Formulation
G. Implementation of Strategy

III. OVERVIEW OF BANKRUPTCY

A. Purpose of Bankruptcy Code
B. Chapter 7
C. Statutory Priorities

IV. OVERVIEW OF CHAPTER 11

A. Creation of Estate and Duties of Debtor-in-Possession
B. Right to Continue to Operate Business
C. Exclusivity Period
D. Disclosure Statement
E. Plan Funding
F. Elements of a Plan
G. Plan Confirmation Process
H. Requirements for Plan Confirmation
I. Requirement That Plan Satisfies ” Interests of Creditors” Test
J. Requirement That All Impaired Classes Have Voted in Favor of the Plan and “Cramdown”
K. Plan Negotiation
L. Alternatives to Debtor’s Plan
M. Seeking Appointment of Chapter 11 Trustee or Examiner

V. PLAN DEFAULT AND POST-CONFIRMATION REMEDIES

A. Effect of Plan Confirmation
B. State or Federal Court Lawsuit for Default
C. Bankruptcy Court Remedies
1. Revocation of Confirmation
2. Modification of the Plan
3. Section 1142 Order to Aid in Implementation of Plan
4. Conversion of Case
5. Other Remedies

VI. RECURRING ISSUES IN CHAPTER 11

A. Introduction
B. Relief from the Automatic Stay (Section 362)
C. Use of Cash Collateral/Cash Collateral Stipulation (Section 363)
D. Sale of Assets Other Than in the Ordinary Course of Business (Section 363)
E. Postpetition Credit (Section 364)
F. Executory Contracts and Leases (Section 365)
G. Equitable Subordination (Section 510)
H. Substantive Consolidation (Section 105)
I. Fraudulent Conveyances (Sections 544 and 548)
J. Preferences (Section 547)
K. Avoidable Postpetition Transfers (Section 549)
L. Setoff (Section 553)
M. Abandonment (Section 554)
N. Claims Litigation

APPENDIX – DRAFT BY-LAWS OF THE OFFICIAL UNSECURED CREDITORS’ COMMITTEE

A Short Series on Security Interests for Credit Managers

by Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.
Creditworthy News

A Short Series on the Disappearing Debtor – Ownership Structure

PART 1: Ownership Structure

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

What happens when a business debtor closes up shop one day only to appear the next day under a slightly different name without going through bankruptcy? How does that happen and what do creditors do?  We call these the Disappearing Debtors.

To answer that question, we need to review what ownership is, how debt is created and whether creditors have rights to attack property in a name other than the original customer. We attempt to do so in this four-part series. Should you have specific questions, please contact Bob Bernstein at bob@bernsteinlaw.com.

Someone asked how businesses shut down only to reopen nearby (or in the same location) under a slightly different name. There are a number of ways that can happen and several things a creditor can do about it. This series will address many of those issues.

To fully address the question, we need to first review different forms of ownership of businesses. A business is a sole proprietorship, a partnership, a corporation, a limited liability company or a trust. There is no such thing as “Jo’s Car Repair” other than one of those. If Jo runs this car repair service out of her garage with some tools and a little bit of equipment and Jo has not created any sort of registered entity for it, then she is personally liable for the debts. Here, Jo probably owns the assets of the business, since Jo’s Car Repair has no existence apart from Jo.

If Jo Smith and Fred Jones start a business together and they run it separately from their personal finances, they are probably a partnership, even though they have not registered it anywhere. It is still a distinct entity. In a partnership, the partners are generally liable for the debts of the partnership. They could register the partnership, but the same liability holds true. If they create a Limited Partnership, then the limited partners (having only invested money and not being involved in management) would probably not be liable beyond their investment. There must be at least one general partner in a limited partnership, and the general partner(s) would be liable for the partnership debts. Sometimes property of a partnership is owned in the names of the individual partners, although a partnership can hold title to property.

If they create a corporation, known as Jo’s Car Repair, Inc., they have created another kind of entity, one that is intended to shield the shareholders and officers and directors from personal liability for business debts, so long as they follow the corporate rules. Likewise, with a Limited Liability Company or a Limited Liability Partnership, the members are generally not liable for the debts of the entity. Each of the limited liability entities (corporation, LLC, LLP) have special rules and special purposes and cannot be treated in detail here. Each of these entities can own the business assets.

In some states, business trusts are created to hold property and operate businesses. They act very much like the other limited liability entities. If you have a situation with a trust as a customer or debtor, please consult your counsel as to the consequences.
Even though the business entities can own the business assets, there could be other holders (partners, shareholders) who could individually own the assets. This becomes important when the assets turn up somewhere else. If your customer (e.g. the corporation) doesn’t own the equipment, it is not available to service your debt later, no matter whose hands it is in.

Next – Part 2: Debt Structure

Collection and Enforcement

Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

I. PREPARING FOR THE DOWNTURN

  • It is important that the company resist the temptation to cut corners on documentation. Documentation is most important when the deal goes bad.
  • Although it is always good to get detailed, accurate and extensive credit information before and during a transaction, it will be especially important to maintain or improve the information when the downturn comes.
  • Since perfection is necessary with leases intended as security, diligence in filing in proper locations is important. We should verify filings and get the customer to cooperate in correcting errors before there is a problem.
  • In short, do all of the right things, expecting it might go bad.

II. WHAT DO WE DO WHEN THE DOWNTURN COMES?

  • Although everyone (including you) may have confidence that the customer can work out of its problems, don’t assume it will succeed. Be careful of letting the customer stretch further and further behind. Watch policies closely on default and enforcement timing.
  • Many lenders and lessors have regular visits to view the equipment or other collateral and verify its existence and condition. At first sign of trouble, make sure to check on collateral and determine what other creditors are doing with (to) customer. If the avalanche is starting, make sure you are way ahead or out of the way.
  • When times get tough, there may be opportunities to restructure deals to allow recovery of more money, rather than more property. Look to other collateral to secure a revised payment schedule.
  • Even though most lessors and lenders and other creditors think of collection agencies and lawyers as the last resort, forward thinkers make sure they have solid relationships with agencies and lawyers in place so they can move quickly when there is a problem.

Consignments: My, How You’ve Changed!

Robert S. Bernstein
Kirk B. Burkley
Bernstein-Burkley, P.C.

While lessors are rarely involved directly with inventory financing, there are times when it is important for them to understand the issues surrounding security interests in inventory. Once in a while, a lessee’s inventory may be looked to as additional collateral in certain transactions. A lessor may also lease/finance goods that become “inventory” in the hands of the lessee (e.g. an equipment rental lessee). A lessor may place recovered goods with a remarketer “on consignment.” As such, it is important for lessors to understand the treatment of consignments under revised Article 9 of the Uniform Commercial Code (the “UCC”).

Consignments underwent a radical change in July 2001, when major revisions to UCC Article 9 (“Article 9”) went into effect. Specifically, the revisions brought all consignments entirely under the scope of Article 9 and removed “non-security” consignments from the purview of UCC Article 2 (in Section 2-326(3)), as that section has been deleted from Article 2.

A consignment is generally understood to be a method by which a vendor (consignor) delivers goods to a customer (consignee) for that customer to hold until it uses them (either in its own operations or by sale to another). When the consignee uses the consigned goods, the consignee has “purchased” the goods and is liable to the consignor for the price of the goods. If he does not sell the goods, he must either return them to the consignor or be liable for the price of the goods. Title to the goods remains in the consignor during the consignment and passes directly to the purchaser, when the goods are sold.

To qualify as a “consignment” under revised Article 9, the goods must be delivered to a merchant for the purpose of sale, have a value over $1,000, and not be consumer goods in the hands of the person making delivery to the merchant. The merchant must deal in goods of the kind under his own name, not be an auctioneer, and not be generally known to sell goods of others. If the consignor does not meet this definition, either because it is consigning consumer goods or the merchant does not deal in goods of the kind, Article 9 offers little protection. The non-Article 9 consignor must look to pre-code law to determine his/her rights. While the drafters of the UCC may have intended that non-Article 9 consignor’s would treat such consignments as bailments and allow them to recover their goods without following the normal steps under the UCC, there is no guarantee this will be the result in the various state courts. Non-Article 9 consignors should familiarize themselves with the applicable state common and statutory law pertaining to bailment to protect themselves and these types of transactions.

It used to be that a consignor protected itself against creditors of the consignee (or against the consignee’s trustee in bankruptcy) by either clearly marking the goods as property of the consignor or by filing a financing statement (UCC-1) covering the consignment. The “marking” frequently took the alternative forms of (a) labeling each piece of the goods as property of the consignor, or (b) segregating the goods in a discrete area designated as containing property of the consignor.

The rationale for this previous system may be instructive. Inventory financers are (or should be) accustomed to regular inspections and counting of inventory securing their debts. Their inspectors will come to the warehouse of, let’s say, a widget seller, looking for security for the debt and see, for instance, a thousand cases of widgets for sale. Since the inventory financer knows the number of widgets in a case and the value of a widget, it could calculate the value of its security.

If, among the cases of widgets, it saw a hundred cases marked “property of and consigned by ABC Manufacturing Co.,” it could know that the inventory secured by the inventory financer’s loan was only nine hundred cases of widgets, rather than the entire thousand. A problem with this system is that there was no convenient way to determine quickly whether the “consigned” widgets were really new inventory or whether those cases had previously been part of the inventory financer’s product. Further, while the “marking” system made logical sense, it left a myriad of questions for courts about how much marking or segregation was enough.

One of the difficulties with the system of “perfecting” consignments by filing UCC-1 financing statements was that when the consignor filed a financing statement covering the goods, it often conflicted with the prior perfected inventory financer and caused the court difficulty in determining the priorities among conflicting holders. Also, the filing often left the consignor (who hadn’t expected to be a secured creditor at all) with a security interest that might not meet all of the tests of perfection.

With the 2001 revisions to Article 9, the drafters determined to place consignments squarely within the realm of security interests. Since the consignor intended to get his specific goods back if there was a problem, the drafters likened the consignor’s interest to a purchase money security interest (a “PMSI”) in inventory (of the debtor). Of course, a PMSI is the lien that a seller (or financer) obtains on goods he sells on credit (or for which he provides funding). Article 9 has always had special treatment for PMSIs. For a PMSI in inventory, there are special priorities as well as special perfection requirements. Since the law now treats a consignment just like a PMSI in inventory, one needs to understand those rules in order to be able to operate in the world of consignments.

Although obvious, it should be noted here that inventory is the kind of secured property that is fungible and changes over time. As old inventory is sold or used and new inventory is purchased, the whole still remains “inventory.” Once a creditor perfects a security interest in a debtor’s “inventory,” all after-acquired inventory falls under that security interest. Therefore, a debtor’s “inventory” can be fluid simply identified as “inventory” without having to specify what is exactly contained within that description. Of course, where appropriate, a seller or lender could identify specific inventory, such as “all inventory of 10-inch widgets” or “all widgets manufactured by ABC Manufacturing Co.”

In order for a PMSI in inventory to have the first lien, meaning a first position ahead of an existing inventory financer, the seller (for our purposes, “seller” includes the provider of the purchase money, whether the seller or another financer) must:

(a) have perfected (by filing a UCC-1 financing statement) the PMSI prior to the time the debtor receives possession of the property;

(b) must send notice of the intended delivery to the inventory financer;

(c) the prior perfected inventory financer must receive the notice within five years before the debtor receives possession of the property; and

(d) the notice must tell the recipient that the seller intends to acquire a PMSI and must describe the inventory to be sold.

These four requirements blend the historical rationale with the desire for uniformity and clarity. The prior perfected inventory financer gets notice before the new goods are delivered, so there is no misunderstanding. The PMSI must be perfected (by filing) before the goods are delivered, which prevents the prior security interest in inventory from attaching to the new inventory before the PMSI can attach.

Determining the appropriate party to whom to give notice is still a bit of a challenge (at least until 2006). Under former Article 9, security interests in inventory were generally recorded in the jurisdiction where the inventory was located. For example, if the inventory was located in the New Jersey warehouse of a Delaware corporation, whose headquarters are in Pennsylvania, the UCC-1 was probably filed in New Jersey. What’s more, in some states, secured creditors were required to dual file, that is, file with both the state and local government.

Under revised Article 9 (effective in almost all states in July 2001), the filing place is the state where the debtor is located. In the above example, since the debtor is a Delaware corporation, it is considered to be “located” in Delaware. This means that, until the old financing statements lapse (a maximum of five years from effective date of revised Article 9), when searching for a security interest, one must examine the filings made in the “old Article 9” filing jurisdictions, as well as the revised Article 9 filing places. What one is looking for is all evidence of existing security interests in “inventory.”

There is good news on the searching front, however. Since all filings (other than for fixtures) are now made centrally (with the state), and since the revisions to Article 9 were also meant to facilitate electronic filing and searching, many states have improved their online searching availability. The bad news is that these online results do not always disclose exactly what the security interest is in, leaving consignors in the dark when looking for inventory financers.

The answer to this dilemma depends upon how much lead time you have before the delivery of the consigned goods to a merchant. If there is ample time, then one can order copies of the prior financing statements to determine the inventory financers and send them notices of the intended consignment before the goods are delivered. The other alternative is to notify all of the holders of security interests that could possibly cover the merchant’s inventory.

Sellers often assess risk when selling on credit. Similarly, they should assess the risk of selling on consignment. When doing so, the seller must understand that an “unperfected” consignment is nothing more than a sale on open account. The seller is relying solely upon the credit of the customer. If the customer fails to make payment, chances are that the “consigned” goods will be snapped up by the inventory financer or by a bankruptcy trustee, and will not be available as security for the consignor. The consignment method was probably chosen in the first place because the seller wasn’t willing to sell on open account. An unperfected consignment means that the seller/consignor has lost its “string” on its goods.

Consignments can be a valuable credit enhancement in the right situation. Like other enhancements, the proper steps must be followed in order to be afforded the appropriate protections. Failure to follow the rules can lead to unintended risks and a failure of protection..

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This article appeared in Equipment Leasing Today , September 2003 (published by the Equipment Leasing Association).