Understanding Your Commercial Rights and Options Before Your Customer or Counterparty Files Bankruptcy
As we move through the last quarter of a year that has included significant consumer and commercial economic turmoil (and into an uncertain 2021), it makes sense for business owners to think about ways to position and protect themselves from customer or counterparty financial distress. Once there is a bankruptcy filing, it might be impossible (or at least much more expensive) to protect your rights. Here are a few ideas to consider.
Monitor Receivables and Think of Ways to Protect the Bottom Line.
While this seems obvious, we often talk to sophisticated but frustrated creditors that failed to act as they watched a customer’s account balance balloon beyond historic levels, or as they watched customer payments slow or become unpredictable or erratic. Quickly identifying problem accounts is critical to determining next steps. Can the customer provide a deposit or letter of credit? Should you move the customer to pre-pay or C.O.D.? There might be a business solution that helps you (and perhaps your customer), but that solution might not be available later, particularly after a bankruptcy filing.
Review Your Contracts and Understand Potential Grounds for Termination.
Once a customer or counterparty files a U.S. bankruptcy case, an insolvency-triggered termination provision in your contract is ordinarily unenforceable. Outside of bankruptcy, however, that provision might provide a basis to terminate a contract and preserve all state law rights. Identifying key contract terms will help a business develop a negotiation or litigation strategy before a bankruptcy filing limits available options.
Identify Lien Rights or Other State Law Creditor Remedies.
Occasionally, we will encounter a creditor that obtained a contract lien right, but the creditor never took steps to perfect the lien under applicable law before the counterparty filed bankruptcy. An enforceable security interest is one way a party may leapfrog above other creditors in bankruptcy payment priority, so perfecting a lien before bankruptcy is critical. In other situations, a creditor might not be aware that state law creates a lien right or other remedy that protects a provider of the relevant goods or services (while the law varies by jurisdiction, the Uniform Commercial Code is one potential source of rights for creditors). Identifying available means for enforcement or preservation of rights can significantly enhance a creditor’s recovery inside and outside of bankruptcy.
Customer or counterparty distress is a recurring problem, even in good financial times. Identifying responsive strategies quickly, however, can help a business minimize the impact of that distress. While the answers might not be certain or appealing, knowing the right questions to ask is key.
ABOUT THE AUTHOR:Henry Flores is Senior Counsel at Rapp & Krock, PC in the Bankruptcy and Creditors Rights group.
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