By Neil Peretz
Given economic conditions and continuing public health concerns heading into 2021, it is looking more and more likely that a tsunami of bankruptcies are on the horizon. Don’t be caught off guard. There are things you can do in advance once you become a creditor to make sure you are well positioned to get the money you are owed.
In Part 1 of our two-part series, we covered the initial steps that individuals and companies should take in the bankruptcy claims process as well as some tips to improve recovery outcomes. In our final part, we’ll discuss the limitations of Ipso Facto, ways to reclaim money owed outside of the bankruptcy process, and how to weigh your fiduciary responsibilities against the time and expense of recovery.
Understand the Fact(o), Jack(o)
It’s not uncommon for contracts to contain a provision that says that the contract can be rendered void or deemed to be in breach upon the filing of bankruptcy by the other party. In fancy Latin legal speech, this is known as an Ipso Facto clause, meaning “by that very fact or act.” Here is an example:
This Agreement shall terminate, without notice, (i) upon the institution by or against either party of insolvency, receivership or bankruptcy proceedings or any other proceedings for the settlement of either party’s debts, (ii) upon either party making an assignment for the benefit of creditors, or (iii) upon either party’s dissolution or ceasing to do business.
While use of a bankruptcy-triggered default clause sounds like a great escape valve for creditors to eliminate the need for bankruptcy strategizing, you should not rely on it or act on it. Even though the Bankruptcy Code expressly states that Ipso Facto clauses are void as a matter of public policy, the routine inclusion of these types of clauses leads to misperception that creditors can just “blow up” a contract and stop providing goods or services when a customer goes bankrupt.
In fact, these kinds of behaviors can ultimately be very costly to the creditor and impact future ability to reclaim what you are owed. While you may be able to take steps to mitigate your exposure once a customer declares bankruptcy, tread carefully and thoughtfully.
One of the best strategies is actually to protect yourself in advance. Draft contracts so you are notified when there is a financial weakness in your counterparty before they actually file for bankruptcy, since you cannot use the bankruptcy itself as a trigger for making changes. This is why banks and other lenders often include covenants related to financial metrics in their documents to allow them to trigger an acceleration and repayment before a bankruptcy is filed.
Cast a Wide Net
While you should always file your claim, there may be other ways to claim what you are owed outside of the standard bankruptcy claims process. While the Automatic Stay may prevent you from directly pursuing collection from a debtor that has filed a bankruptcy petition, it does not prevent you from pursuing non-bankrupt entities that may also be liable. Double-check that contract: maybe your agreement is with a subsidiary or affiliate of the debtor, rather than the debtor itself. If so, you are not subject to the bankruptcy claims process when seeking repayment. Likewise, if there is a guarantor on the contract, the filing of bankruptcy does not prevent you from pursuing the guarantor for recompense if the guarantor has not also filed bankruptcy. Doing a little legwork, may help you get what you are owed.
You can actually plan ahead to give your business the most flexibility for repayment options. If you are in an industry with high insolvency risks or know you are doing business with an entity that is at risk of filing bankruptcy, examine whether there can be a cosigner on the contract that has less solvency risks. If it is a smaller business, you may be able to secure a personal guarantee on the contract, which gives you another venue to pursue repayment at the same time you are filing a bankruptcy claim.
Be a Careful Fiduciary
Before you write off what you are owed for cents on the dollar, remember that having a fiduciary duty obligates you to act in the best interest of another party, typically an employer. In the case of bankruptcy, this often translates to being able to demonstrate that you pursued options to ensure the best chance for a positive financial outcome. So how do you assess what actions are in the best financial interest of your company?
As you are assessing the next steps (once you discover you are a creditor in a bankruptcy filing), consider the following questions:
- How much money should I spend on specialized bankruptcy attorneys (perhaps at $500 per hour) to pursue a claim that might be worth $45,000 or might instead be worth much less at the end of the day?
- Am I in a fiduciary role where I am obliged to try to collect on monies owed and document for auditors that I acted diligently?
- How much time do I have to keep track of the case and deadlines?
- Do I know enough about bankruptcy law to take advantage of special rules that could advantage my claim?
Unfortunately, you typically will not know until the end of a bankruptcy case the size of the recovery on your claim. But waiting to file may cause you to miss important deadlines, including the claims bar date. And not filing at all not only ensures that you won’t reclaim anything, but may also indicate to auditors and others that you’ve shirked your fiduciary responsibility by not actively trying to get what you are owed.
As a former general counsel and practicing bankruptcy attorney, I have been working with a new company called Proxifile.com that has finally addressed the hurdles faced by creditors in the bankruptcy process. For very little money upfront, an expert bankruptcy attorney helps position your claims to maximize recovery and meet beat deadlines with very little work on your part. We would be happy to tell you more.
About the Author:
Neil Peretz has served as general counsel of multiple companies, as well as a corporate CEO, CFO, and COO. Outside of the corporate sphere, he co-founded the Office of Enforcement of the Consumer Financial Protection Bureau and practiced law with the US Department of Justice and the Securities and Exchange Commission. Peretz holds a JD from the University of California, Los Angeles (UCLA) School of Law, an LLM (master of laws) from Katholieke Universiteit Leuven (where he was a Fulbright Scholar), bachelor’s and master’s degrees from Tufts University, and has been ABD at the George Mason University School of Public Policy. Peretz’s most recent technology endeavors are serving as general counsel to Contract Wrangler, which applies attorney-trained artificial intelligence to identify the key business terms in a wide variety of contracts, and co-founder of Proxifile.com a new, hassle-free method for creditors to stake their claim in bankruptcies. Follow him online at linkedin.com/in/neilperetz.