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So, Your Customer Just Filed Chapter 11; What are the Five Things You Should Do Today?

April 20, 2020 

By
Lea Pauley Goff
Member, Stoll Keenon Ogden PLLC
(502) 568-5731
lea.goff@skofirm.com

The American Bankruptcy Institute reports that that business bankruptcy filings were up 14 percent in the first quarter of 2020, compared to the first quarter of 2019. Since the pandemic crisis really did not cause economic havoc until March of this year, bankruptcy filings are expected to grow throughout the year. Therefore, the present time could in some ways be the calm before the storm.
 
When your customer files for Chapter 11 bankruptcy protection, much of the case may play out over the next few months (or even years).
 
However, there are some decisions you will need to make in the earliest days of the case. Where to start when you get that notice?
 
Make Sure Your Colleagues Are Mindful of The Automatic Stay
 
In the vast majority of cases, as soon as a bankruptcy petition is filed, the “automatic stay” arises. It stays most activity by creditors against the filing Debtor and its property, except as the Bankruptcy Court specifically permits. Thus, your company cannot undertake or continue activities such as sending collection letters, repossessing property or filing a lawsuit against the Debtor. Other activities that are not so obviously actions “against” the Debtor can also be stayed, such as set-offs and some (but not all) lien filings. The automatic stay is one of the foundational bases of the Bankruptcy Code. Courts take it seriously and will impose sanctions for knowing violations.
 
Gather Your Documents
 
This sounds dull and purely administrative, but it is important. Ideally, you would have all of your contracts (including amendments) with a particular customer readily at hand, along with the forms you use for the relationship. If so, access them now. If not, get them together. You should assemble materials including:
 
A.     All current contracts with the customer, including amendments, extensions, credit applications and guaranty documents;
B.     Any letter of credit, bond or other security for the account;
C.     All forms you would use for that customer relationship, including purchase orders, order confirmations, bills of lading, etc.
D.     All outstanding invoices;
E.     All invoices for goods (not services) received by the customer from you in the 20 days before the bankruptcy case is filed; and
F.     An invoice and payment history for the 27 months before the date of the bankruptcy filing.
 
Determine If You Have Goods in Transit or Immediate Service Scheduled
 
If you have goods in transit to the customer when the case is filed, the first question you may have is “Can I instruct the truck to turn around?” This may depend on the terms of your contract and the ownership of the goods at the time. If you have a strictly purchase order relationship, and your terms have the ownership of the goods changing at the point of delivery (i.e. your company still owns them when you learn of the bankruptcy filing), you may have the option to stop the transit. If by the terms of sale the customer already owns the goods, then action to stop delivery could be a stay violation. If you have services to the Debtor scheduled immediately, whether you must perform them may also depend on your contract, or the lack thereof, as discussed below.
 
Determine Whether You Must Continue Supplying the Customer Post-Bankruptcy
 
You should consider whether you want to continue supplying this customer and, if not, whether the bankruptcy filing requires you to do so. First, if you have no contract with the customer — i.e. you simply supply through purchase orders — you likely can discontinue shipments absent new terms of which you approve. If you have a contract but you terminated it prior to the bankruptcy filing, the bankruptcy code does not resurrect it, so you likely can decline more business or get better security (i.e. payment in advance). However, if you have an unterminated contract that would require you to continue supplying the customer absent the failure to pay and the bankruptcy filing, you generally will not be able to terminate the contract after the bankruptcy filing and the Debtor may argue that you must keep shipping or risk violating the stay. In that event, you may want to seek relief from the Court, including some protection against non-payment by the Debtor. There are exceptions that permit vendors to terminate certain types of contracts notwithstanding the bankruptcy filing but you should not assume you can do so without confirming that you indeed meet one of the exceptions.
 
If You Are Willing to Keep Supplying, Assess What You Want in Exchange
 
If the customer has a contract with you that it can enforce pre-petition, you may have to continue that same pricing and other terms. If there is no enforceable contract, you may be able to set better terms post-petition (both in terms of pricing and security) if the Debtor really needs you as a supplier.
 
Consider pricing, payment terms, the length of the commitment and any need for court approval if you make a new deal with the Debtor. You have a couple of options for getting the prepetition amount paid as part of that new deal. The general rule is that a Debtor is not permitted to pay prepetition claims, except in the context of a plan or other approved distribution.
 
However, there are exceptions. For example, courts will nearly always approve payment of pre-petition wages. What about payments to vendors? The two principal ways that vendors can be paid for prepetition claims earlier in a case are (a) the assumption of their contracts; or (b) through a critical vendor order.
 
The Debtor may bring your contract current if it assumes that contract but may be reluctant to assume it early in the case. The Court may also, at the Debtor’s request, enter an order permitting the payment of some or all the claims of “critical vendors.” Some courts do not like these orders, but many will enter them, and they are common in larger cases.
 
If the Court approves that mechanism, and the Debtor views you as an important vendor who might not otherwise be willing to keep supplying it, you would negotiate with the Debtor to pay all or a part of the claim, usually in return for a commitment by the vendor to extend to the Debtor the same post-petition payment terms as it extended prepetition.
 
You will have many other issues to assess in the days to come, such as plan terms, contract assumptions, the Debtor‘s sale of assets, etc. However, this list of your first day items should give you as good start at minimizing the fall-out from the customer’s filing.

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Stoll Keenon Ogden understands that these are trying times for our clients and our country. Our firm operations have continued uninterrupted and our attorneys are equipped to serve as we always have – for over 120 years.

Attorneys with Stoll Keenon Ogden PLLC’s Bankruptcy and Financial Restructuring Group would be happy to help assist small businesses and their creditors.

Please also be sure to consult the Stoll Keenon Ogden Coronavirus Resource webpage for additional articles and information related to the latest information on new laws and directives enacted by federal, state, and local governments in response to the Coronavirus pandemic.