Corporate Bankruptcy A to Z
Corporate Bankruptcy A to Z
Bankruptcy Traps — Part 2 Short
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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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You are listening to Corporate Bankruptcy A to D, a podcast that gives you the ins and outs of corporate bankruptcy. This is an abbreviated release of episode 4 Part 2, where we will cover what happens to company assets after filing, how cash can be used, paying creditors and employees, court approvals, and how long a company may remain in bankruptcy. 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-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 UI, a bankruptcy attorney with over 40 years in the field. If you are dealing with the 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_03For this episode, we have a special guest, Michelle Novick of Solio Inc. After filing for bankruptcy protection, who gets control over assets like cash in the bank, accounts receivable, and inventory? Can the company use the cash as it did before the bankruptcy filing?
SPEAKER_00Not exactly. The simplest way for debtor to obtain the use of cash is by first receiving the consent of the debtor's current lender. And at that time, the debtor must demonstrate that the secured lender's interest in the cash collateral is adequately protected. To ensure that a secured lender receives sufficient adequate protection, the company will need to open a debtor in possession bank account and pay creditors who are allowed to be paid pursuant to a court-approved monthly operating budget. And usually that's with the approval of the debtor secured lender. The debtor must receive the consent of that lender who has a lien on those assets.
SPEAKER_03It must be a very strange meeting for the bank to say, hey, this company just filed for Chapter 11 and they want to use the money that's in the bank.
SPEAKER_00Yes, that's what they do. But the alternative is if they don't let them use some of this cash collateral to operate in a Chapter 11 case, the company's going to fail, and they may, if they sell at liquidation value, they may not pay off the secured lender's outstanding claim. So I think both parties need to have the dialogue early. They need to talk about it and see if they can come up with a compromised solution on the use of cash.
SPEAKER_02If the company is allowed to operate in a chapter 11, the return to the bank on its collateral may be many more times than the liquidation value. So it's very important that the parties not hide in their corner or under a rock because uh the discussions and communications at the early stages and even before chapter 11 really could make or break how the Chapter 11 is going to work out and how the return to the creditors, including unsecured, will be.
SPEAKER_03Can the company sell any of its fixed assets or real estate?
SPEAKER_00Anything that the company does outside of the ordinary course of business needs bankruptcy court approval. But yes, the company can sell its fixed assets in real estate in bankruptcy. And that has been the primary reason that companies have filed bankruptcy over the last several years to sell their assets free and clear of liens, claims, and encumbrances.
SPEAKER_03What about the creditors? Can the company pay creditors or vendors from debts that occurred prior to the bankruptcy filing?
SPEAKER_00No, that is a definite no. So any and all debts which occurred prior to the bankruptcy filing cannot, and I can't stress this enough, cannot be paid until the company receives bankruptcy court approval for any of those payments.
SPEAKER_02As we discussed again in a prior podcast, there is this concept of critical vendors, which, if there are vendors that are so critical to the debtor's operation, and those creditors are in essence holding up the debtor to say, pay my pre-Chapter 11 debt, or we will not provide product post-Chapter 11. The debtor can apply to the bankruptcy court for permission to pay these so-called critical vendors. The courts used to be a lot more liberal in recognizing so-called critical vendors as critical, so the tests have gotten a bit tighter over the years. But that is an instance where a debtor can pay pre-Chapter 11 creditors, but only by court approval.
SPEAKER_00As a result, the bankruptcy court will generally not allow retention bonuses and raises to employees while vendors remain unpaid.
SPEAKER_03What about company perks like cars, health insurances, cell phones, et cetera?
SPEAKER_00Generally, those issues are dealt with in uh at the beginning of the case, and they're usually dealt with in first day motions. So right when the case is filed, now when you say company car, health insurance, cell phones, you know, where do you draw the line in terms of what would be allowed for the employee to keep? Is it necessary for the business? Can they not conduct their business without their car or their cell phone? And generally health insurance is, in my opinion, is allowed.
SPEAKER_03How long can a company stay in bankruptcy?
SPEAKER_00Well, there's no time limit that I'm aware of on the duration of a bankruptcy case. Some chapter 11 cases wrap up within a few months. Most cases generally take six months to two years, I would say, before they're closed.
SPEAKER_03Is there any benefit to staying a shorter time or a longer time, except from the professionals' point of view of earning fees?
SPEAKER_00If you don't want a bankruptcy court looking at every step of the process that a company undertakes, and you don't want somebody looking over your shoulder, monthly operating budgets that are extensive, I would say the shorter the time, the better.
SPEAKER_02Chapter 11, as we've discussed over and over, is very expensive. And the longer you're in it, the more expensive it gets. What is an exclusivity period?
SPEAKER_00That's a period in chapter 11 where the debtor has the exclusive right during the first 120 days of the case to file a plan of reorganization. They have the sole time period. No one else can file a plan during the first 120 days. It gives them an advantage to control the case and the narrative of the case. During that period, the debtor works diligently to prepare a plan of reorganization to be confirmed or blessed, in other words, by the bankruptcy court. And that most companies file these type of cases so that they get that exclusivity period to formulate a plan and find out how best to pay creditors.
SPEAKER_03The company has submitted a plan to the court that includes payments to creditors. Are all creditors treated the same?
SPEAKER_00No, not at all. Um, the bankruptcy code prioritizes who gets paid and in what priority. Generally, secured claims are paid first. That is any entity that has a lien on the debtor's assets. After secured claims, the bankruptcy code prioritizes claims that have been given administrative priority. These administrative claims can include professionals, the attorneys, financial consultants, accountants who represent the debtor and creditors. So they are entitled to an administrative priority claim.
SPEAKER_03What are the different classes of creditors and which get preference over others?
SPEAKER_00After secure creditors, administrative creditors take priority, and then there are priority claims for other specific groups that the legislative body has put in. Most people talk about priority claims, they're talking about administrative claims and employee claims.
SPEAKER_02And a couple other categories, which are taxes. It's a very important uh category of priority claims, as well as what are called deposit creditors, which has been big these days or over the last 10 years in retail cases, where if a creditor has put down a deposit of X dollars for a purchase, part of that deposit is entitled to a priority.
SPEAKER_03What happens if employees are owed money when the company filed for bankruptcy?
SPEAKER_00That generally happens, for example, when an employee is due to be paid, say on a Friday for wages earned by Wednesday, and the debtor then files bankruptcy on a Thursday. Those issues are usually resolved in a first-day motion filed by counsel for the debtor, seeking to have the employees get paid under that doctrine of necessity. It's a catch-all. And usually those are allowed because they need the employees and they don't want employees walking out right at the time the case has been filed. The only benefit to a chapter 11 is to see that this company gets reorganized in an orderly fashion, and employees are generally needed to help the company survive.
SPEAKER_03How are existing contracts treated in a bankruptcy?
SPEAKER_00So existing contracts are referred to in the bankruptcy code as executory contracts. Although that's not a defined term in the bankruptcy code, most courts have adopted the definition that an executory contract is, quote, a contract under which the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach, excusing the performance of the other. So, in layman's terms, that means that contracts where performance remains due on both sides are executory. What happens with these executory contracts is as follows they could be real estate leases, equipment leases, development contracts, or an intellectual property license. And a debtor then needs to decide whether to agree to perform its obligations under the executory contract. While the debtor is in bankruptcy and deciding how to treat the executory contract, whether they want to assume it or reject it, the debtor must continue to perform under the terms of the contract. If the debtor absumes the contract, the debtor has to pay what is called a cure payment in full of all defaults and show that it can actually perform in the future.
SPEAKER_02A typical executory contract is a real estate lease. Those landlords become unsecured creditors, and the other 50 the debtor can assume and operate in its now reduced 50-store footprint. That's part of what reorganization and restructuring is all about.
SPEAKER_03Continuing on the real estate lease, my experience has been that most real estate leases for smaller companies are personally guaranteed. So when you say that the debtor doesn't necessarily have to continue with that contract, would the real estate company, the landlord, then be able to go after the personal guarantee of the signing?
SPEAKER_02Yes.
SPEAKER_00Yes, that is true. And again, we represent the company if we're debtors counsel, not the individuals. And so that if it's best for the company to forego 10 leases on its retail space in Illinois, and one of the principals has guaranteed it. Unless that principal is an acre seat himself or herself, that guarantee is going to continue and probably result in litigation.
SPEAKER_03Are contracts with family members treated differently than outsiders?
SPEAKER_02There will always be more scrutiny of contracts with family members or insiders than the typical contract with an unrelated third party.
SPEAKER_00Well, that's why it's so important to get the advice on legal counsel ahead of time, because that legal advice will help you decide what you can and cannot pay when the corporation is in what is known as the zone of insolvency. You know, liabilities are greater than the asset, it's financially underperforming. Who do you pay and who do you not pay? Free bankruptcy planning, I can't stress enough, is very important.
SPEAKER_03We have covered much in this podcast, and the biggest trap is yet to be discussed. Given the company has submitted a plan, does the court necessarily have to accept the plan as submitted?
SPEAKER_00No. Or sometimes it's a plan of liquidation. If it's an orderly liquidation in a chapter 11, is filed with the bankruptcy court generally after discussions with main constituents in the bankruptcy case, including the secured lenders and the official committee of unsecured creditors, and there could be other relevant parties, bondholders, um, etc., that are involved in the case. So usually the first initial plan that is filed is not the final plan that's confirmed by the bankruptcy court. There are many iterations of a plan before one is you know thought to be confirmed. To be legally effective, a chapter 11 plan must be confirmed by the bankruptcy court. And when that judge signs that order, it provides provisions and rules that the debtor and all creditors and interest holders are bound by once that plan is confirmed and approved.
SPEAKER_02A chapter 11, actually, as you're talking about it, makes me think that a chapter 11 is almost like a board game where the final box on the board is the approval or confirmation of the plan by the bankruptcy court. But along the way, you have these negotiations and setbacks where, for example, if there's an objection to your plan by the creditors committee, you're gonna have to go back 10 spaces to renegotiate so that you can get back to going forward toward that final box.
SPEAKER_00But just don't go to jail and pass going.
SPEAKER_02Well, that happens too, as we see.
SPEAKER_00Right, right. You know, bankruptcy fraud is also looked at very closely by the Office of the United States Trustee. And so as you're doing these negotiations, there is a third-party watchdog of the government looking over the shoulder of the debtor to make sure that all decisions are made in conformance with the bankruptcy code.
SPEAKER_03Michelle, this has been extremely informative. Is there anything you'd like to say to our listeners in closing?
SPEAKER_00Right. Number one piece of advice I would leave listeners would be that companies facing financial distress would be to meet with a bankruptcy attorney, a financial consultant early in the process, someone that has a lot of experience. That way you can control the narrative both externally and internally with the company's employees, vendors, creditors, and other critical parties. Having these discussions early on in the process allows the company to be proactive in its approach rather than being reactive, which usually does not result in the most desirable outcome. So to get the most out of a bankruptcy filing requires a team approach, a collaborative approach, and can be done with reputable counsel and financial advisors. It's nothing to be ashamed about, it's nothing to be fearful about. Just please be proactive.
SPEAKER_03Steve, any parting comments about this episode?
SPEAKER_02It is important, everything that Michelle just said, but also what's important is that the company has to make sure that they disclose everything about the company. And I've mentioned this before. One little detail that the company does not disclose, either intentionally or unintentionally, can change the whole course of a case. So it's very, very important that the company put all of its cards on the table when dealing with its own professionals.
SPEAKER_01Do 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 website. Go to corporatebankcyatz.com or elementary business.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.