With Pandemic comes Bankruptcy. The United States Bankruptcy Courts have reflected an astonishing increase in Bankruptcy filings since the start of the COVID-19 Pandemic in early March. It’s not just Hertz Rental Car and J.C. Penney that are feeling the pain from the global economic shutdown. Many smaller businesses, faced with an immediate slow-down in business and impaired cash-flow, have been forced to seek bankruptcy protection.
How Does a Business Contemplate Navigating a Bankruptcy?
The purpose of the bankruptcy laws is to treat all similarly situated creditors equally so that one does not receive more favorable treatment than another. This is most commonly accomplished through Chapter 7 (Liquidation) or Chapter 11 (Reorganization). Under Chapter 11, the Debtor’s business continues to operate and attempts to reorganize under a through a plan of reorganization approved by the Bankruptcy Court. Under Chapter 7, a bankruptcy trustee is appointed to collect, liquidate and distribute the Debtor’s assets to creditors. The first question a party must ask themselves is, what type of bankruptcy has been filed.
The Chapter 7 Bankruptcy (Liquidation)
In a Chapter 7, the Debtor is closing shop. They are liquidating their assets. The Debtor turns over all non-exempt assets to a bankruptcy trustee appointed by the Bankruptcy Court to liquidate the assets of the Debtor’s “estate.” The trustee is obligated to generate as much income as possible through the liquidation of the Debtor’s estate. From these assets, creditors are paid in the following order: secured creditors who have legal rights to a particular asset are paid when that asset is sold; next, administrative expenses incurred for services provided after the bankruptcy petition was filed, such as legal fees and accountant fees, are paid; after that, pre-petition wage claims and taxes are paid; then general unsecured creditors are paid. However, in most cases, recovery by general unsecured creditors will likely be minimal.
If you are owed money in a Chapter 7 Bankruptcy, your best bet to recover anything is to timely file a Proof of Claim. When the Debtor files bankruptcy, a schedule of the Debtor’s assets and liabilities is filed with the Bankruptcy Court. From this schedule, the Bankruptcy Court will notify you, as a creditor, when to submit a Proof of Claim stating the amounts you are owed. The Proof of Claim should include all amounts owed to the creditor including potential future or contingent liabilities such as potential delay or liquidated damages. The Bankruptcy Court will set a deadline or “bar date” for filing a Proof of Claim. If a Proof of Claim is timely filed and the bankruptcy is an “Asset Bankruptcy” there is a chance you can get some money. It will not be the full amount. In a “No Asset Bankruptcy,” good luck. There are no available assets to pay your claim. Meaning, the Bankrupt Debtor owed much more to its creditors than it had in the bank.
The most important point to remember in a Chapter 7 Bankruptcy is to file a Proof of Claim should you be notified by the Bankruptcy Court that there may be assets to disburse. Proof of Claims often have very specific deadlines listed in the claim forms. If you miss those deadlines, you miss out on your opportunity to receive any form of payment through the Bankruptcy.
The Chapter 11 Bankruptcy (Reorganization)
A more complicated Bankruptcy is the reorganization. The business is not liquidating (shutting its doors) but is instead reorganizing its debts in order to attempt to get back on track as a viable business. The debtor continues to operate its business under supervision by the Bankruptcy Court which has broad authority to govern the Debtor’s business. Typically, Chapter 11 Bankruptcy is more complicated than Chapter 7 because it often involves a large number of creditors seeking to get the most amount for the claims they are owed.
If you have an existing contract with the Bankrupt Debtor, the Debtor has the right to assume your contract (accept it) or reject the contract. Typically, a contract will be assumed if it has value to the Debtor. If not, it will be rejected. If the Debtor chooses to accept your contract, you will be paid for the work going forward, but there is no guarantee on the amount you will be paid for your prior work. Generally, any payment for prior work is subject to approval by the Bankruptcy Court. If the Debtor rejects your contract, you will likely be considered a general, unsecured creditor, and will be lucky to recover much of what you were owed prior to the Bankruptcy filing.
Any creditor whose claim is not listed by the Debtor on the Debtor’s schedule of liabilities or is listed as disputed, contingent, or unliquidated must file a Proof of Claim in order to be treated as a creditor and participate in the plan to reorganize the Debtor. In most cases, a creditor’s committee is formed by the largest unsecured creditors. This committee monitors the Debtor’s activities and attempts to agree with the Debtor on a plan of reorganization. Any plan of reorganization must be approved by the Bankruptcy Court to be effective. If the Debtor and the creditor’s committee cannot agree on a plan of reorganization, the Debtor can propose and seek Bankruptcy Court approval of a plan of reorganization. If the Debtor’s plan is not approved, a creditor or the creditor’s committee can seek approval of its plan of reorganization for the Debtor. Ultimately, if a plan is not eventually approved, the Bankruptcy Court will likely convert the case to a Chapter 7 liquidation.
Unfortunately, in many cases a Chapter 11 bankruptcy filing is converted to a Chapter 7 liquidation because the reasons why the business declared bankruptcy remain and the business cannot be reorganized to allow it to operate in an effective and profitable manner. In this event, a creditor will likely receive less than it would have received if the bankruptcy was initially filed under Chapter 7.
Chapter 11 Bankruptcy is expensive and can last awhile. In some cases, Chapter 11 proceedings last for several years. If you find yourself a party to a Chapter 11 Bankruptcy reorganization it is very important to retain legal counsel early in the jurisdiction where the Bankruptcy is located. Oftentimes Bankrupt parties in a Chapter 11 file immediate motions which may prejudice or impair your rights to receive payment through the Bankruptcy process.
For more information on Chapter 7 and Chapter 11 Bankruptcies, please contact Lanak & Hanna Senior Counsel Mark D. Johnson, [email protected] or call 1 (714) 451-7875.
The information contained herein is not advice and should not be treated as such. You must not rely on the information as an alternative to legal advice from an appropriately qualified attorney.
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