In the midst of the unprecedented global health challenge presented by the spread of the coronavirus (COVID-19), businesses will almost certainly face pervasive disruptions to operations as the economy experiences widespread financial distress. In light of the dramatic and continuing economic downturn, and with the certainty that almost every business sector has been or will be affected, it is imperative that each company have a plan for handling relationships with companies in financial distress. From taking steps to enhance credit protection prior to a counterparty faltering, to exercising state law rights and remedies upon default, to understanding the bankruptcy process, this article will provide an overview of items for each business to consider. For a more in-depth look at these and other issues, see our article “In-Depth Look at Managing Customer Relationships in Troubled Times.”

Dealing With Delinquent Customers: Identifying the Warning Signs

Some of the typical early warning signs include (1) slow payment and/or a change in long-standing payment terms, (2) a change in the method or source of payment, or (3) a change in purchasing patterns.

Once a problem credit relationship arises, the credit professional must consider the possibility that the customer could file bankruptcy in the near future. Therefore, during this period, there must be two primary goals. The first and most obvious is the collection of the outstanding receivable or the recovery of the product sold. The second involves minimizing the risk of later having to give the money back as a result of preference or other litigation.

Pre-Bankruptcy Planning

Once a credit problem arises, the credit professional should determine whether the business is being conducted under a contract or on a purchase order basis. If there is no contract, a supplier can almost always require cash-on-delivery terms. You should work with counsel to ensure the process for utilizing other Uniform Commercial Code protections is correctly followed.

Next, when a credit problem arises, the credit professional should quickly determine what other payment or risk mitigation options exist or could become available upon demand, including setoff, letter of credit, third-party guarantee, reclamation, stoppage in transit or obtaining a security interest in collateral.

The Bankruptcy Filing

Bankruptcy law is found in Title 11 of the United States Code, which is referred to as the Bankruptcy Code. Types of business bankruptcies typically include the following: Chapter 7, the most commonly filed type of bankruptcy in the United States, which permits individuals, corporations and most other entities, with some exceptions, to have their assets liquidated and the proceeds distributed to their creditors; Chapter 11, which is typically filed by corporate entities seeking to reorganize or sell their assets as a going concern; and new subchapter 5 to Chapter 11 of the Bankruptcy Code, which aims to make small business bankruptcy proceedings more expeditious and efficient for the debtor company. The goal of Chapter 11 is to confirm a plan that either salvages the debtor’s business or details the manner of liquidating the debtor’s business, or some combination of the two.

Creditor Issues to Be Considered in Bankruptcy

• The Automatic Stay. The “automatic stay” goes into effect immediately and, among other things, prohibits any act to collect a prepetition claim against the debtors, including the commencement or continuation of judicial, administrative or other actions or proceedings.

• Creditor’s Committee Participation. In a Chapter 11 case, an official committee of unsecured creditors generally consisting of the debtor’s largest creditors is often appointed. The committee has a fiduciary duty to represent the interests of all creditors and helps shape the direction of the case.

• Doing Business With the Debtor-in-Possession. The debtor is authorized to continue to operate its business and, in the ordinary course of business, is authorized and required to pay for post-petition goods and services. Amounts owed for goods sold and/or services rendered after the commencement of the bankruptcy case is elevated to an administrative claim.

• Section 503(b)(9). The Bankruptcy Code also creates a right to administrative priority for the value of any goods sold, but not services provided, to the debtor in the ordinary course of the debtor’s business that were received by the debtor within 20 days before the bankruptcy filing.

• Proofs of Claim. Must be filed timely in Chapter 7 and 13 cases and must also be filed timely in order to obtain a distribution in a Chapter 11 case if the claim is not properly listed in the Schedules of Assets and Liabilities or is listed as contingent.

• Avoidance Action. May be brought against a creditor that received payment within 90 days before bankruptcy on account of a preexisting debt. There are numerous defenses to these actions, and bankruptcy counsel should be consulted.

• The Critical Vendor Doctrine. A bankruptcy court may be persuaded to permit the debtor to pay the pre-petition unsecured claims of certain key vendors and suppliers in the first few days of a bankruptcy case. Check with counsel on availability.