Bankruptcies serve a necessary function in the free enterprise system, providing a legal means to, as equitably as possible, either reorganize or redistribute the assets of failed enterprises.
From a creditor perspective, the bankruptcy process provides the last opportunity to recover what you can from your terminally ill customers. Doing so requires an understanding of bankruptcy laws and processes and, most importantly, a methodology for insuring that the necessary steps are taken to protect your company's interests.
This Best Practice Installment will focus on the process of handling and filing bankruptcy claims to best ensure that is accomplished.
Principles
For many credit departments, customer bankruptcies are an occasional occurrence, but in some industries and for many larger enterprises, customer bankruptcies are commonplace. In either situation, the goal is to as efficiently as possible take the necessary steps to make sure your firm gets its share of any asset distributions.
Because the legal process associated with any bankruptcy is going to run its own course in its own time, credit pros are often inclined to take a "once and done" approach upon notification of customer bankruptcy. "There is a tendency to file immediately, and I would say that is generally a best practice. There are some issues that do arise, however, and you need to have those in mind when you sit down and go through this thing to decide if you should file the claim," notes creditors' rights and bankruptcy attorney Richard Macias. That is why you need a methodology that covers all your options whenever you are presented with a customer bankruptcy.
Benefits
Establishing guidelines for handling customer bankruptcies provides a variety of benefits:
- Ensures you recover everything you are due. This is the goal. You don't want to lose out because of a missed deadline or some other oversight.
- Eliminates any ambiguity from your claim filing process. When you spell out in advance what needs to be done and when there is no need to relearn the process each time out. This is especially critical when you are not regularly dealing with customer bankruptcies.
- Ensure all tasks are handled within accepted parameters. Being efficient guarantees that everything is handled in a timely fashion so you can move to other critical tasks where your efforts can add value. You don't want to waste time handling bankruptcy claims.
Recommendations
- Know how much you are owed. You not only need to know this amount, but you also need to be able to document it.
- Capture all records for future reference. Because bankruptcy claims can take several years to adjudicate, you don't want old records to disappear. It is therefore very important that you preserve the account history, including relevant invoices. Should a preference claim arise, you will want to have three to four years of sales and payment history. If the corporate archives are electronic, you will want to make copies, either electronic or paper, to be kept in a separate file.
- Know the BAR date on claims. Generally, there is a notice sent out within the first 60 to 90 days after a bankruptcy filing setting the BAR date. While it is not recommended you wait until the last minute to file a claim, there may be extenuating issues that make it advisable to hold off on your filing (see next item). In any event, you should never leave bankruptcy on the back burner.
- Determine if there may be any issues that would be better adjudicated in a US District Court as opposed to the Bankruptcy Court. If you suspect there may be account reconciliation issues, claims for unauthorized credit (e.g., advertising), preference claims, or fraud to name a few, you may want to hold off filing a bankruptcy claim. "Once filed, you've submitted yourself completely to the jurisdiction of the Bankruptcy Court. There is some authority that says if you have not submitted to the jurisdiction of the Bankruptcy Court you may have a right to a jury trial in the Federal District Court on issues that may arise during the case," explains Macias. The advantage of a District Court is the additional judicial resources they offer. Bankruptcy Courts and Trustees are overwhelmed by their caseload. "You're really focusing not so much on litigating things as opening a window to settling it," he adds.
- Don't file a claim if you receive a No Asset Notice. There is no point in filing a claim because there is no mechanism for the court to record your claim. If assets are found, you will be notified.
- Don't rely on the debtor's schedule to determine if you should file a claim. Most schedules do not indicate whether a debt is disputed or not, and often a debt for one reason or another can become disputed during the course of bankruptcy. Unless your debt is clearly listed as undisputed in the debtor's schedules approved by the court, you should file a claim.
- Distinguish between secured and unsecured debts. This is important if you are a secured creditor. You will need to file a separate claim for each.
- Identify Administrative Claims separately from any other claims. In Chapter 11 cases, administrative claims have to be paid before the reorganization plan can be confirmed. "The revisions to the code established a class of creditors that were called administrative creditors -- there have always been administrative claims -- but they now include in that class people who sold goods in the ordinary course of business within 20 days prior to the filing of the bankruptcy," says Macias.
- Before filing a Reclamation Claim make sure the inventory has not been sold or is not part of the collateral of the senior secured creditor. With the advent of just-in-time inventory systems, seldom will your goods still be in your customer's possession. Also, if you are selling unsecured, your reclamation claim will be trumped by the security interest of the senior secured creditor. Most of the time you will be better off filing an administrative claim.
- Make sure you file your claim with the appropriate party. "There is a tendency to assume you file the claim with the court. In many instances, especially in bigger bankruptcies, a mechanism is set up that is out of the court system, where the filing is done with a claims administrator," observes Macias. Chapter 7 trustees often hire an outside vendor to handle claim administration. If you mistakenly file with the court, your claim could be denied.
- Include a return receipt envelope with your claim. It's not enough to just file a claim. Sometimes you will need proof, and the way to do that is to send a duplicate with a return, stamped envelope.
Reporting and Performance Measures
- Record key bankruptcy data in a registry in order to monitor the bankruptcy process. While there are some automated systems that have facilities for tracking bankrupt customers apart from other receivables, most of the time you will have to do this manually. Unless you have very high bankruptcy volumes, a spreadsheet should do nicely. Otherwise, you may want to use a database. In any event, you will want to track the total amount, claims by type (administrative, reclamation, secured, unsecured), recoveries by type, the BAR date, the date your claim was filed, confirmation it was filed, current status, and so forth. Essentially, you want the ability to track all activities associated with bankruptcy.
- Trends. Besides helping monitor the process of your customer's bankruptcies, over time a bankruptcy register will enable you to report on bankruptcy trends such as:
- Year-to-year or month-to-month number and dollar amounts of bankruptcy filings
- Year-to-year or month-to-month dollars outstanding in ongoing bankruptcies
- Year-to-year or month-to-month recoveries from bankruptcy
- Year-to-year bankruptcy filings (number and dollar amounts) by customer type/AR segment.
- A year-to-year comparison of average bankruptcy filing amount by customer type/AR segment
As a final thought, keep in mind that good metrics on your bankruptcy exposures will not only help you keep on top of ongoing bankruptcies but also provide intelligence for calculating your firm's allowance for doubtful accounts.
Case Study: Milking the Bankruptcy Process for All It's Worth
Western Milling, LLC sells animal feed, mainly to dairies. When we interviewed him, dairy operators had been experiencing higher feed costs and lower milk prices, resulting in a spike in bankruptcies. "Our main salvation," notes Robert Simmons, Western Milling's Credit Manager, "comes from securing the debt by utilizing Deeds of Trust and/or UCCs. Another advantage is having an attorney who understands the dairy industry and the animal feed business and wants to help the dairyman survive. He also works extremely well with the debtor's attorney."
Simmons also has set procedures for handling bankruptcy claims. As a result, he is not only able to maximize his firm's recoveries, but also leverage the situation to Western Milling's advantage when the dairy exits bankruptcy. Here's how he does it:
- Even though Western Milling is a secured creditor, Simmons takes advantage of any opportunity to recover funds through an administrative claim. "I make a list of shipments in the 20 days prior to the bankruptcy filing and submit a 503(b)(9) claim to be paid as an administrative claim from future cash flow," he states. Not only does he stand a chance of getting a portion of his money sooner, but he also is sure of recovering 100 percent on the administrative claims.
- Since there are many feed companies to choose from, becoming a critical vendor is not an option. Because cows need to eat, Western Milling instead works closely with the bankrupt dairyman and his attorney to continue deliveries post-filing with payments made from the bankrupt owner's first use of cash collateral approved by the court.
Due to Western Milling's willingness to work with bankrupt owners and their accountants and attorneys, they get requests to supply feed to some post-bankrupt accounts previously supplied by competitors. As the old saying goes, the cream rises to the top.
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