Bankruptcy Traps — Part 1 Short

Topics

• Preference claims & lookback periods
• Keeping vendors happy before filing
• What business owners need to know
• Best time to file

Guest: Josh Eppich — Bonds Ellis

This is an abridged version of the original episode. Feel free to go back and listen to the full version in our show feed.

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Transcript

SPEAKER_01 0:01

You are listening to Corporate Bankruptcy A to Z, a podcast that gives you the ins and outs of corporate bankruptcy. This is an abbreviated release of episode 4, where we will cover common bankruptcy traps, including preference claims, look back periods, personal guarantees, and how creditor actions can impact the outcome of a case. If you are new to the show or want to hear the full conversation about this topic and more, we invite you to check out our full bankruptcy series found below in the show feed. There you will find an unedited version of each episode where we dig deeper and answer more questions. Corporate Bankruptcy A to Z is hosted by Neil Goldstein, a chief restructuring officer with over 30 years experience. He is joined by co-host and legal expert Steve Raven of Sol Ewing, a bankruptcy attorney with over 40 years in the field. If you are dealing with a situation now and need guidance, you can reach out to them directly. Call Neil at 940-808-9451 and Steve at 973-286-6713.

SPEAKER_00 1:09

For this episode, we have a special guest. The podcast is extremely happy to have Josh Epic of Bonds, Ellis, and Epic. Josh, we have been preparing our listeners for this episode by alerting them the bankruptcy process is like a minefield. Each step may have an unexpected disruption to their plan.

SPEAKER_03 1:32

So I guess one side views them as a trap, the other side views them as a uh a tool, right? And I I mean you can refer to the bankruptcy process as a minefield, or you can view it as a giant puzzle. Um, but when you look at a bankruptcy process, a lot of times you have a company that has a finite amount of resources, and the resources aren't sufficient to pay off all the debt. So you have creditors who are trying to find a way to either get a larger share of that pie than they would normally get, or they're trying to come up with a way to expand the pie.

SPEAKER_00 2:17

So included in that attempt to get back some funds to pay all the creditors would be preference claims and look back periods, personal guarantees, and looking at the ownership of the company.

SPEAKER_03 2:32

Sure. What if we do like a running hypothetical? That may help describe a lot of the questions. So you have Bob who started a trucking company, a logistics company, and Bob has grown his logistics company to 20 million in revenue, and he's got 40 trucks, and they're running routes all over the southwest United States. So he's leveraged up on his trucks, he's gone ahead and say he's factored some of his receivables, and he can't make his payments to the bank. Now, likely when he entered into his loan with the bank, he signed a personal guarantee because the bank's not going to lend him any money if he doesn't backstop it. So he starts talking to the bank and he starts talking to the factoring company, and he has a bunch of vendors who he's got to pay, a bunch of you know, contractors, and he's got employees. And so he's looking at having to file for bankruptcy on October 1st. And he knows that he has some creditors that if he doesn't pay them, they're not going to uh continue to provide him services. Say, for example, his fuel card that he's got to pay to keep his trucks going. Certain creditors, whether they're secured or unsecured, or or or they're creditors who he has personal obligations on, and he pays a couple of those before the bankruptcy within the 90 days. And that 90-day window is really important because the typical preference look back, unless you're looking at an insider, under the bankruptcy code is 90 days. So he files for bankruptcy on October 1, but he made a bunch of payments to different creditors on, say, bankruptcy day minus 20, minus 40, minus 60. What'll happen is he goes into bankruptcy. If it's a typical chapter 11, he'll be what's called a debtor in possession. So he's still running the company, but he has to work with the creditors, mainly his secured creditors and those who have a lien on cash, and in this case a factoring company, which can be very aggressive, to continue to have cash to operate. Well, somewhere along the line, if an unsecured creditors committee comes into play, they're going to go back the 90 days before bankruptcy and they're going to look at all the payments that were made. And theoretically, they could sue every single one of those parties saying that they got a preference. And they're supposed to do an analysis and look to see if there's any reasonable defenses, and then there's floors on how much the claim can be. If you're an insider, you look back a year. So if you made payments, for example, distributions to yourself as the owner during that one year, and those were outside the normal operations of the business, then someone will come back and look at those. Normally, either a trustee or a committee, or the debtor itself technically has an obligation to go back and look at those. And you also have what are called fraudulent transfers, and they can go back two years, or if you go under state law, sometimes four years, depending on the state. But what when you're looking at fraudulent transfers, it's it's not a typical fraud. It's a math calculation of reasonably equivalent value.

SPEAKER_00 6:17

Well, let's stay on Bob's trucking company for a moment. And the example you gave was he needs fuel for his trucks. So he makes payments, maybe in excess of what is owed, to get into the good graces of the trucking company, knowing he would need them after the filing. And the court comes back and says, okay, a preference claim occurred. We want some of the money back. Would that fuel company have any future claim against the company? Or after they gave back the money, due to the preference, it's a dead issue.

SPEAKER_03 6:56

Well, if I were the fuel provider, I'd call it a prepayment, and so it's a preference defense. I wouldn't pay any of the money back.

SPEAKER_02 7:04

Oftentimes, Neil, when when there is a preference claim against a party, and that party starts talking to the trustee or the creditors committee about settling, part of the settlement will be that the creditor will uh waive their entitlement to a claim in the bankruptcy. Uh, so that's often a component of these settlement discussions.

SPEAKER_00 7:33

My experience with clients has been that certain vendors are so angry at the filing and the preference claim that when the company in bankruptcy tries to do business with that vendor in the future, the vendor raises the prices with the goal of getting back some of the money they lost due to the bankruptcy. Is that legal?

SPEAKER_03 8:02

So I take care of that a different way. On the first day of the bankruptcy, I file what's called a critical vendor motion. And if I have certain vendors that have to be paid to keep the business going, I request court approval to pay their pre-petition claim on the condition that they will continue to do business with the debtor under the pre-petition uh terms. But that's the threat, right? If you're the vendor, is that you'll stop doing business with the debtor and you'll cause them to shut down. Now, the question would be whether that's a violation of the automatic stay, and you have to go and look at the agreements that are in place between the debtor and the vendor.

SPEAKER_00 8:54

Well, let's delve deeper into look back periods. The look back period you said was 90 days for vendors. Should a company plan when to file based upon the 90-day period? Is there an advantage to the company when looking at a specific date to file?

SPEAKER_03 9:16

Absolutely. One of the first things you do when you're preparing for filing is you get a list of all the payments that have been made and you look at who they're being paid to, and you can certainly try to push out the date when you file to get certain payments outside of those 90 days.

SPEAKER_00 9:37

How about for insiders? You mentioned that insiders have a you said a one-year look back period.

SPEAKER_03 9:43

So let's use your guarantee example is say you have a uh an owner of a company who guaranteed an obligation, but from the company's perspective, that obligation is an unsecured claim. But from the owner's perspective, he would be liable because he guaranteed that. If he directs the company to pay off that obligation, then that is a transfer of funds that could be a preferential treatment or preferential payment because he got the benefit to the exclusion of other creditors.

SPEAKER_00 10:20

Are there any other examples you can give?

SPEAKER_03 10:24

Uh if you decided to make yourself a very large distribution and you don't normally make that distribution.

SPEAKER_02 10:32

Or if the principal of the company loaned the company money and got paid back within a year prior to the filing, that is a clear preference.

SPEAKER_00 10:44

Steve and I worked on a case for a paper company where the owner would make purchases from his personal funds. He put the personal funds into the company, make the purchase, sell the paper, and then pay himself back from the proceeds of the sale. And what I learned from Steve was each of those transactions was subject to the one-year look back period for insiders. I think the listeners should be aware and speak to their counsel about situations like that. Most business owners had to give a personal guarantee somewhere along the line. How are personal guarantees made by owners treated in a corporate bankruptcy? And can you give us an example?

SPEAKER_03 11:34

So the personal guarantee is outside of the bankruptcy. And at least under Texas law and the way most of the loan documents are drafted, the lender can go after the individual because he's not a party to the estate. So he doesn't get the protection of the automatic stay. The automatic stay is important because when the bankruptcy is filed, it's supposed to give the debtor breathing room. Now there are things you can do. You can file a motion with the bankruptcy court and say that the automatic stay for a certain period of time should be applied to the owner of the company because he has to operate the company and the estate is going to be irreparably harmed if he's having to fight these lawsuits against him personally in state court at the same time as trying to reorganize the company.

SPEAKER_02 12:37

On that note, it used to be that what Josh is talking about would be a motion to extend the automatic stay to protect the individualslash guarantor. And in my experience, at least in New Jersey courts, those motions were routinely granted early on. And then as time went on, and let's say 15 years ago, it became more and more difficult to get to convince the court to extend the automatic stay.

SPEAKER_01 13:11

Do you have a question about bankruptcy? Why not ask the experts? Emails for Neil and Steve can be found in the show notes below. And remember, the first call is always free. Call Neil at 940-808-9451 and Steve at 973-286-6713. You can also find more resources on our websites. Go to corporatebankruptcyA to Z.com or elementarybusiness.com. You can also find links to those in the show notes down below. Corporate Bankruptcy A to Z podcast and YouTube channel are produced by me, Sir Isaac Smith. Be sure you subscribe and share the episode, and we will see you next time.